According to section 1 of the Partnership Act 1890, the definition of a partnership is: “the relation which subsists between persons carrying on a business in common with a view of profit”. It is this relation between two or more persons (each person can either be an individual or another legal entity classed as a person such as a limited company), which is perhaps the most crucial characteristic of a partnership. It is impossible to hold out a business structure as being a partnership without at least two persons.
If any type of partnership falls below two persons for any reason, e.g. if there are only two individual partners and one dies, it will automatically be deemed to be dissolved. The remaining person can then choose to carry on the business as a sole trader or set up a limited company. Alternatively, they can find a new partner and form a new partnership.
Sharing profits, losses and responsibilities
Profits and losses are generally shared out equally between all the partners unless agreed otherwise and – aside from the case of Limited Partnerships and Limited Liability Partnerships (see below) – all the partners are jointly and severally liable for all the debts and liabilities of the partnership.
Subject to specific agreements to the contrary, all partners are entitled to take part in business decisions and the overall management of the business. Conversely, each partner is responsible for any acts or omissions of other partners acting “in the ordinary course of the business of the firm” (section 10 Partnership Act).
Taxes paid individually
Partnerships are transparent for tax purposes; no tax is levied upon the partnership itself – instead each partner is accountable for paying their income tax according to their personal share of profits and expenses.
What are the main types of partnerships?
Most partnerships are ordinary partnerships, as set out by the Partnership Act 1890. An ordinary partnership is not a separate legal entity. It is a group of two or more persons carrying out business together.
Each individual partner acts on behalf of the other partner(s) when negotiating and entering into contracts with third parties, and all partners are jointly and severally liable for any debts and obligations of the partnership as a whole, without any limitation. If the partnership is sued, this effectively means that each partner can be pursued individually by a creditor who is trying to recover any debts.
All partners owe each other fiduciary duties, including an undertaking to:
- Render accounts and full information with regards the partnership (section 28 Partnership Act 1890)
- Account for any personal profits made during the course of partnership business (section 29)
- Not compete with the partnership without the consent of other partners – and to hand over any profits generated (section 30)
Many partnerships will have a partnership agreement. This sets out the various rights and responsibilities of individual partners, including stating any bespoke split of profits, decision making processes and the procedure to take in case a partner leaves (see below for more information about partnership agreements).
Limited Liability Partnership (LLP)
The Limited Liability Partnerships Act 2000 introduced a new form of legal entity to the UK in 2001 – Limited Liability Partnerships (LLPs). LLPs are essentially a hybrid of an ordinary partnership structure and a private limited company, combining the benefits of both forms of business entity.
Unlike a conventional partnership, an LLP is an incorporated company and, as such, it is considered to exist as its own legal person. It can own assets and borrow money on its own account.
As with all partnerships, LLPs must have at least two persons, who are known as ‘members’ (these are essentially the partners). There can be any number of ordinary members but there must be at least two ‘designated members’ who are responsible for:
- registering the partnership for VAT if annual turnover is expected to be in excess of £85,000
- appointing an auditor (if required)
- maintaining accounting records
- preparing, signing and sending annual accounts to Companies House (for more information on LLP accounts see GOV.UK – LLP accounts)
- sending confirmation statements to Companies House (for more information on LLP confirmation statements see GOV.UK – LLP confirmation statements)
- keeping Companies House up to date with relevant administrative details, e.g. if there is a change of registered name or address, etc.
- acting for the LLP if it is wound up and dissolved
A major advantage of forming an LLP is that its members/partners are not personally liable for any debts incurred by the partnership. Furthermore, unlike an ordinary partnership, fiduciary duties are generally not owed between partners. Instead they are owed by each partner to the LLP.
Similarly to an ordinary partnership, profits made by the LLP are distributed to partners, who are responsible for paying their own personal income tax.
The process for incorporating a Limited Liability Partnership is broadly similar to the incorporation of a limited company:
- A name must be chosen which isn’t offensive or too similar to other registered business names. It must also end in ‘Limited Liability Partnership’ or ‘LLP’ (or the Welsh equivalents).
- There must be a registered address to which official correspondence can be sent. It must be a physical address and in the same country in which the LLP is registered. PO Boxes can be used but they must still be followed by a physical address. The registered address will be publicly available.
- The LLP must be registered electronically using third party software; or by paper and post, using form LL IN01; or using an authorised company formation agent such as Quality Company Formations.
- At least two designated members must be specified (see above).
- Consider making an LLP agreement (similar to a shareholders agreement) which sets out how the Limited Liability Partnership should be run (see below for further information).
Quality Company Formations provides a Limited Liability Partnership Package for just £29.99 plus VAT. It includes registration of the LLP, digital and printed LLP incorporation documents and a draft LLP agreement.
Limited Partnership (LP)
Although LLPs are a relatively new form of business structure in the UK, partnerships with an aspect of limited liability have been around since the Limited Partnerships Act of 1907, although they are seldom used these days. A Limited Partnership (LP) is not an incorporated business structure and does not have its own legal status.
Individual partners are still responsible for entering into contracts on behalf of other partners. However, in an LP it is possible to designate certain partners as ‘limited partners’ who do not take part in the management of the partnership and, crucially, have limited liability (limited to their capital contribution) for any debts incurred by the partnership.
Limited partners, sometimes known as silent or sleeping partners, are normally investors who do not wish to take an active part in running the business. At least one partner in an LP must be a non-limited partner (referred to as a ‘general partner’) – they will have unlimited liability.
Which partnership type is best for me?
The main choice to make when considering setting up a partnership will be between an ordinary partnership and a Limited Liability Partnership. It may be useful to consider the pros and cons of each:
Pros – since this is not incorporated, there is less administration and associated costs, e.g. annual filings. Accounts do not need to be published or made publicly available which may be beneficial if this information could be valuable to competitors, etc.
Cons – all partners are personally liable for any debts incurred by the partnership. The partnership does not have its own legal personality, e.g. it cannot trade or borrow money on its own account.
Pros – liability of partners/members is limited. Incorporation means that the business has its own legal entity.
Cons – duties of running an incorporated company, e.g. annual filings. Income must be disclosed.
The third option – the Limited Partnership, in practice was only useful before LLPs came into existence in 2001. Most people who may have decided to set up an LP would now choose to form an LLP.
It is recommended that partnerships adopt a partnership agreement, or in the case of LLPs, an LLP agreement. These documents essentially set down the rules under which the partnership (or LLP) operates, and include matters such as:
- Capital contribution of partners and profit share.
- Management of partnership and the decision making process.
- How to manage the exit of a partner.
- Defining responsibilities of partners (to one another or to the LLP).
It should be noted that Limited Liability Partnerships Regulations 2001 contain ‘default provisions’ which govern certain aspects of running an LLP in the absence of an LLP agreement. Putting in place an effective partnership agreement helps to ensure the smooth running of the business and provides a way of resolving many of the disputes which may arise.