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Are you interested in going into business with another person, such as a friend or family member? Are you wondering what the best way to structure this relationship is? Is a business partnership better than creating a company? This article will explain the critical differences between companies and business partnerships and the advantages and disadvantages.
Overview
Different sets of laws govern partnerships and companies.
There are two primary forms of business partnerships:
- general partnerships; and
- limited liability partnerships (LLPs).
In partnerships, the partners share in the profits and the losses of the business. Each partner has broad authority to act on behalf of the partnership. While many partnerships split profits and losses evenly, some partners can receive more profits than others. This will be based on the partnership agreement between all the partners. Likewise, the partnership agreement will specify the extent of each partner’s powers and responsibilities.
For companies, ownership in the business is based on the number of shares each shareholder has. However, being a shareholder does not give you an automatic right to make decisions on behalf of the company: to do this, you must also be a director.
We will now go on to consider the legal definition of:
- general partnerships;
- LLPs; and
- private companies limited by shares.
Partnerships
In both general partnerships and LLPs, the partnership agreement sets out the rights and obligations between all the partners.
The partnership agreement is a contract between each of the partners that specifies essential terms such as:
- how profits and losses will be split;
- the power of the partners to act on behalf of the partnership; and
- how to remove partners from the partnership.
General Partnerships
The law recognises general partnerships automatically if you and your partners carry on some business activity and share in the profits and losses.
General partnerships are not capable of existing as incorporated entities. This means that your partnership:
- cannot own property in its name;
- cannot enter into contracts in its name; and
- cannot defend itself in the event of any dispute.
This means that each partner will be responsible for the partnership’s actions and the other partners. So, for example, if the partnership cannot pay a debt or is sued, the partners themselves will be held personally liable.
LLPs
LLPs do not arise automatically. Instead, you must create the LLP by filing certain documents with Companies House. The law refers to each partner as a “member”, and they will collectively ensure that the LLP keeps up to date with its Companies House obligations, such as filing its annual accounts.
This means that in the event the LLP cannot cover its own debts, the liability of each partner will not be unlimited as they are under a general partnership. Likewise, suppose your partner acts in an improper way or outside the bounds of their powers as a partner. Again, under an LLP, you will not be personally liable for their mistake, though the partnership itself will have to account for the errant partner’s error.
Private Companies Limited by Shares
Nearly all companies are private companies limited by shares. This means that ownership is determined by how many shares you hold in the company. This provides for more flexibility where different parties have contributed different amounts to the company.
If you want to ensure that each “partner” (i.e., shareholder) has the same rights to share in the profit, each shareholder will need to be issued the same number of shares and have each “class of shares” be the same.
The company structure is less flexible when specifying other matters, such as the amount each “partner” should work. For instance, you cannot simply specify this in your company’s constitutional documents, including its articles of association, because these documents only apply to rights and obligations owed by the shareholders as shareholders. You cannot try and create private obligations between each shareholder in their capacity, such as each partner’s right to serve as a director.
You can create a “shareholder agreement” that will practically give effect to the same terms you might specify in a partnership agreement. This is because the shareholder agreement is a private document between each shareholder in their personal capacity.
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Comparing Partnerships and Companies
In determining which business structure is suitable for you and your business partners, there are a few key things to consider:
- do you want to benefit from limited liability?
- how flexible do you need the relationship between you and your partners to be?
- do you have any plans to admit new members to the business?
- how much administrative burden are you and your business partners willing to shoulder?
Generally, general partnerships and LLPs provide more flexibility than companies and require less administration, especially general partnerships.
On the other hand, companies are more common. It can be easier to raise capital because much of corporate finance is based on using a company’s share capital, especially when raising equity finance. However, LLPs can still borrow money much the same way companies can.
Key Takeaways
If you want the rights and obligations of each partner to be the same, you can easily set this out in the partnership agreement of either an LLP or general partnership. Achieving the same effect under a company structure requires more steps. Companies do have inherent benefits, particularly regarding the legal and commercial importance of share capital when raising finance. Neither general partnerships nor LLPs are capable of having share capital. Therefore, before entering into a partnership agreement or incorporating a company, you and your business partners should consider obtaining legal advice on which structure and under what terms works best for each of you.
If you need help creating a company or partnership, our experienced corporate lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today at 0808 196 8584 or visit our membership page.
Frequently Asked Questions
Fundamentally, business partnerships and companies operate under different legal mechanisms. For instance, the owners of a general partnership are called “partners”, whereas, under a company, they are called shareholders. Practically, either business structure can give effect to specific agreements you and your business partners want to enter into, though this will likely require legal advice.
In short, by default, a general business partnership will automatically grant each partner the same rights and obligations as the others because the law implies equality among all business partners absent any express agreement that says otherwise. In other words, you and your business partners could start trading, and as long as you have not done anything that indicates otherwise, the law will assume everything is equal between you.
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