Being a team player off the pitch
As a player, you know where you are on the pitch. Off the pitch, and when it comes to business, it can be a different matter. You might be approached with a suggestion that you invest into a partnership – but what exactly does that mean? This article attempts to answer the question in layman’s terms for you.
A partnership is a legal agreement between two or more individuals, to work together with a view to making a profit. Each partner will typically invest some of their own money in an effort to get the business off the ground. There are three main types of partnership - General Partnerships, Limited Partnerships (LP) and Limited Liability Partnerships (LLP). Although the way that a partnership works may seem similar to a company, there is a fundamental difference in the way in which a partner might be held liable for any debts or losses – and the different type of partnership is the deciding factor. A General Partnership and its partners are not separate legal entities. This means that when the profits start to roll in, each partner stands to earn a share. But it also means that if the business is losing money, the partners are personally responsible for ensuring that the partnerships’ debts get paid.
It is possible to reduce this risk by either forming an LP or an LLP. As a limited partner in a LP you are only liable for the amount you initially invest. Each LP must have at least one general partner and the general partner has unlimited liability – which means that he or she can be held liable for everything. The general partner stands to have more to gain should the partnership achieve a great result and you might be enticed to take up the role of General Partner on that basis – but beware, because if things go wrong, you might find yourself being chased for all of the partnership’s debts.
In an LLP, similarly to a company, all partners have limited liability for the debts of the partnership. In each LLP there must be at least two designated partners who have more responsibility than other partners, including ensuring that annual accounts are accurate and filed with the registrar of companies.
Partnerships kick off with the creation of a partnership agreement. Be wary of anyone who suggests that you enter into a verbal agreement. Even with the best and closest of friends and family it is better to ensure that there is a written agreement which sets out clearly the responsibilities of and rewards due to each partner. Whilst you might want to keep legal costs to a minimum, this is one of those instances when it would be wise to get a lawyer to draw up an agreement – or to review any agreement that you are asked to sign. And it may be best to seek your own lawyer, rather than relying on your friend’s lawyer, to ensure you get truly independent advice.
Although partners may start out as close friends with the best of intentions, it is far from uncommon for business stresses to take their toll on relationships and, come half-time, you may be less than pleased with the actions of some of the players on your team. Friendships tend to go out of the window as money troubles (or indeed profits) come through the door. At times like this there is comfort to be had in the legal backing of a formal partnership agreement.
Partners can receive income in the form of a salary, called drawings, paid out by the partnership or as a share of the profits of the partnership. The ratio in which profits are shared amongst the partners is usually set out in the partnership agreement and is completely up to the partners. Many factors are usually taken into account when deciding upon the amount to be paid to each partner. These can include such things as how active the partner might be in the daily activities of the company – are they actually going out and selling the business or have they simply put money in and sat back? - how much money they invest to help get the company off the ground and how much the other partners value the expertise that they are bringing to the business.
There can be tax benefits from setting up a partnership. A company must pay tax on its profits before making payments to shareholders in the form of dividends. The shareholders then get taxed on the dividends, meaning that the company’s profits are effectively taxed twice. In a partnership any profits shared out to the partners are not taxed prior to being shared out. Instead the partners are charged income tax on their share of the partnership profits. On top of this, as the partners are essentially self-employed, they pay National Insurance Contributions (NIC) through their self-assessment, with NIC being charged at the lower rate for self-employed individuals.
Creating a partnership is a big commitment but, like a football team, if you have the right players and the right game plan, it holds the possibility for great success. But, like football, before joining the team, make sure you study and understand the contract.
If you would like further details or advice on the creation or management of a partnership, please call Mazars LLP on 0207 063 4639 or 0161 831 1312.