This is the second article in our series of common business structures. Last month we discussed the pros and cons associated with sole trader structures. If you haven’t read that article as yet and would like to know more, you will find it here.
What is a partnership?
Another common business structure we see is that of a Partnership. A Partnership structure may be a suitable structure when you are starting a new business and you are looking to ‘share the load’ with your business partner, but are wanting to keep things simple.
Despite what many people think when they hear the term ‘partnership’, a partnership can be formed between two or more people, you aren’t limited to two people only.
A general, or common law partnership, the most common type of partnership structure we see when it comes to business arrangements, is one where the partners come together to carry on a business jointly. In doing so, they share the profits or losses generated by the business equally based on their partnership share in the business. In the absence of an agreement stating otherwise, this is normally an equal share based on the number of partners (eg. two partners are 50/50 whilst three partners would be one third each).
A partnership is not a legal entity in its own right. It is the partners themselves that are the legal owners of the business and subsequently are responsible for the business risks associated with the business. This is a particularly important point given that partners of a partnership are joint and severally liable, meaning that they are responsible for all of the business risks and liabilities, not just their own share.
A partnership is also not a taxable entity in its own right, with the tax obligations associated with profits and losses sitting with the partners to address. However, a partnership is still required to lodge an annual income tax return disclosing its activity and what has been allocated to its partners.
What are the advantages and disadvantages of a partnership structure?
Operating a business under a Partnership structure of any kind has its benefits. But as we saw with the sole trader article, it is important to acknowledge that with benefits comes potential risks. We have outlined the pros and cons of a partnership structure below for you to consider:
- Relatively easy and cost effective to establish and administer with slightly more involved than sole trader but less than more complex structures
- Generally, has fewer reporting requirements than other structures
- All partners are taxed on profits generated at individual marginal tax rates – beneficial subject to level of profits realized
- Partners are able to include partnership losses in individual tax returns, which can help reduce taxable income from other sources
- Having more than one person involved in the business and decision making can help ‘lessen the burden’ compared to being in business on your own, and also provides the opportunity to bring different skills and expertise
- You can employee people to help run your business and conduct your business operations similar to that of other structures
- Its possible to change into a more advanced corporate structure as your business grows and develops
- You are jointly (with the other partners in proportion to ownership structure) legally responsible for all aspects of the business. This means that any liabilities incurred by the business become your personal liability, potentially exposing other assets you own
- Getting finance/loans can be a bit trickier compared to more advanced structures
- Taking leave to get away or if you’re unwell can be harder to do, as if the partners are the ones running the business, the day-to-day running of the business can suffer and therefore impact potential profits
- You are taxed as an individual on all profits generated which can lead to higher than necessary tax impost at times
- Multiple people making decisions can be tricky if there are conflicting opinions and disagreements
- Difficult to change the ownership in adding or removing partners
- The more partners involved in this structure, the more complex they can become
What should I consider before entering into a partnership business structure?
Partnership structures do have a purpose where the business activity or arrangement suits. Before you proceed with this type of structure however, it is important that you seek advice on how to establish your partnership to maximise the benefits this type of structure brings whilst mitigating the risks.
Steps such as considering which of the partners of the structure will be given the joint and several liability exposure is important as a partnership does not have to be one of individuals, it could be a partnership of companies or a partnership of trusts. Having a formal agreement prepared to allow for quantifying different ownership percentages (if relevant), as well as streamlining the succession of partners on entry or exit to avoid having to register a new partnership upon every change, is also important.
The team at Davidsons can assist with this type of guidance and help you identity the best structure to suit your needs. Things that you consider important to you will impact on the type of structure chosen and are built around your thoughts regarding:
- Who can make important decisions
- The tax advantages and disadvantages
- How profits are disbursed and shared
- The legal obligations and costs
Davidsons can also help to identify whether the structure that suits you is a partnership or one of the other common structures we see, namely:
- Sole Trader
The key is getting the right advice at the start of your business journey.
If you would like to discuss how to structure your new business, or consider the structure of your existing business, please contact the Davidsons team on 03 5221 6399 or at firstname.lastname@example.org for further information and to schedule a no charge meeting with one of our Tax and Business Services specialists.
Please note that this article has been limited to the working of a general, or common law, partnerships. There are other options when it comes to partnerships, such as limited partnerships as well as forms of joint ventures that have not been discussed in this article.
Disclaimer: this information is of a general nature and should not be viewed as representing financial advice. Users of this information are encouraged to seek further advice if they are unclear as to the meaning of anything contained in this article. Davidsons accepts no responsibility for any loss suffered as a result of any party using or relying on this article.