Given that market conditions are constantly changing, it is not unusual practice for a business partnership to recruit a new additional partner to either change the trajectory of the business or to increase its growth. Regardless of the reasons, there are important steps that need to be taken in preparation for admitting a new partner to your business.
Review Original Partnership Agreement
The proposed admission of a new member should serve as a catalyst for a review of your original partnership agreement, if you haven’t already done so. Your business will have evolved since its inception, and it is critical that your agreement is up-to-date and reflects any developments.
Although a new partner joining a business marks the beginning of a journey, one should begin with the realistic understanding that at some point all partnerships will come to an end. With this in mind, the best method to safeguard a business’s interests, is to agree on everything up front in a complete agreement.
While it is not imperative for a business partnership to have a partnership agreement, it is advisable. Whether your business is a Limited Partnership, Limited Liability Partnership, or a General Partnership it is important to have a written agreement that carefully outlines the terms of the business relationship. Without a partnership agreement the partnership is governed by the Partnership Act 1980. This can be problematic as the Act is rigid in its terms, for example it states that partners share equally in profits, it also states that a partner cannot retire or be expelled, and that if a partner leaves the partnership for any reason, the partnership must be dissolved and a new partnership formed.
When bringing on a new partner, any initial partnership agreement should be evaluated by a solicitor. The solicitor will identify and enable the necessary amending of any changes or additions appropriate to the new agreement.
As the Partnership Act is so broad, if a provision in the partnership agreement is overlooked, the Act is unlikely to provide the level of specificity that the partners may seek.
When setting up a partnership it is important to ensure sight of any additions or changes in regulations around partnerships.
Fit for Purpose Partnerships
General partnerships are created when two or more people join in a common enterprise with a view to profit regardless of whether they have an agreement. Partnership law has long held that where one person holds herself out as partner of another they will be treated as being partners for the purpose of dealings with third parties.
Herein lies the main disadvantage of partnerships: unlike shareholders in a company, partners are jointly and severally liable for each other’s debts and acts. However, an advantage of this traditional business vehicle over companies is that partners share in profits and losses, making it tax transparent in comparison to a company which is subject to tax on its profits, which when distributed to members (shareholders) in the form of dividends are taxed again in the hands of the members.
The Limited Liability Partnership (LLP) brings with it all the benefits of general partnerships, including tax transparency but without the disadvantage of joint and several liability. Thus the LLP has become the preferred business vehicle used by architects, lawyers, investment bankers and other professionals.
It is worthy to note that Limited Partnerships and Limited Liability Partnerships require registration and are governed by their own legislation. This makes them slightly more difficult to set up but can also provide extra protection to its directors through more specific legislation.
Key Considerations
Regardless of the type of partnership, it is extremely important to ensure your agreement includes any specific considerations that fit the profile and needs of your business partnership.
This way, the agreement brings accountability by role players and partnerships within the ambit of the Act.
The Act provides for:
- how new partners are taken in
- how assets and capital brought into the partnership are owned
- how partners are to be paid and how profits are divided
- expenses
- day to day management of the business
- the process around retirement
- the circumstances, and the process by which a partner may be removed from the partnership
It is important to note which aspects covered in the Act cannot be changed, and these include the rules relating to taxation. So specific provisions for this must be included in a partnership agreement and are deliberated upon below.
Paid-in capital
Should the new partner be required to provide capital to the partnership, an important consideration will be how and when that capital is to be paid. Is the partnership to anticipate receiving a one-time payment upon the new partner’s admittance, for example? Or will this amount be paid in instalments over a specified length of time, either from private money or through a new partner’s agreement to take lower withdrawals for a specific number of years?
It will be prudent to ascertain from the new partner, where they intend to get the money for their capital commitment. If a loan is anticipated, it will be important to determine if the partnership will be required to provide any kind of security or enter into a guarantee agreement. Any loan conditions must also be evaluated to verify any provisions impacting the partnership, are appropriate and enforceable.
Profit-sharing considerations
Ordinarily, the new partner will be entitled to a share of the partnership’s earnings so, the partnership agreement should clarify how this would operate. Is it standard practice in the partnership to pay all partners a basic wage initially, and then regard any remaining money as profit eligible for distribution, or will the partnership take a different approach? Are earnings distributed evenly between partners, or assigned according to a predetermined ratio? If so, is this ratio constant or prone to change?
Rights and responsibilities of the new role
There must be clarity on the new partner’s role as well as the rights and responsibilities that come with the position. The expectations of both parties, within the partner relationship must be considered and agreed upon. This will save time, expense and dissention, in the event of a dispute.
Amount of control awarded
In our experience, it is critical to address the following aspects of control:
- the new partner’s level of power
- the managerial responsibilities a partner will be expected to take on
- the extent to which partners will be controlled and their performance evaluated
- the systems in place to help them if they fall short of agreed performance criteria
The question of control must be explicitly addressed as part of the talks around the new partner’s admittance. All parties should be clear about the level of power attributed to each partner including how voting rights will be organised, both in terms of day-to-day operations and, more crucially, for key business decisions.
Undefined boundaries concerning levels of authority perceived by individual partners in crucial decision-making, is at the heart of many of the partnership disputes we encounter.
Notifying relevant parties
The nomination of the new partner must be documented, either in a freshly prepared partnership agreement, or in a deed of adherence or admittance if the previous partnership agreement is to remain in effect.
To guarantee accuracy and ensure the agreements made are legally enforceable, all documentation is best verified by a solicitor.
It is critical that everyone knows that a new partner has been appointed. Your bank, HMRC, professional advisors, and the partnership insurers are among the numerous organisations to be formally notified. Notifying essential customers, suppliers, and service providers is also prudent and courteous.
In summary, although having a partnership agreement in place is not compulsory, we strongly recommend having one. Engaging the services of your legal representative when bringing a new partner onboard, will ensure that you have covered all your bases, and provides clarity on the structural changes of the business for all parties involved.
Written by George Marques, Head of Corporate
Email: gmarques@redfernlegal.com
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