Partnership agreements

What the Partnership Act 1891 gives you by default

These rules apply automatically unless your agreement says otherwise. Most people are surprised by at least two of them.

That last row is the sharp one. If your partnership has no fixed term, one partner can dissolve the whole firm by giving notice, and the business then has to be wound up and its assets realised unless the others can agree otherwise. That is a very poor outcome for a business with goodwill, staff and a lease.

What your agreement should change

1. Capital and profit. How much each partner contributed, how profit and loss are shared, whether working partners draw a salary before profit is split, and what drawings each partner may take.
2. Decision making. Which decisions any partner can make alone, which need a majority, and which need everyone. Put a dollar threshold on it so it is objectively testable.
3. Restrictions on authority. Limit the ability of one partner to borrow, give guarantees, employ people or commit the firm beyond a set amount. This binds the partners between themselves, though a third party who does not know of the limit may still hold the firm.
4. Admission and retirement. How a new partner joins, notice required to retire, and whether a retiring partner is indemnified for firm debts incurred after they leave.
5. Death, incapacity and default. Continuation of the firm rather than automatic dissolution, and a compulsory buy-out of the outgoing partner's interest at an agreed valuation.
6. Valuation and payment. The method for valuing an outgoing interest and the terms on which it is paid, because a lump sum can bankrupt a small firm.
7. Restraint and confidentiality. What a departing partner may do and which clients they may approach.
8. Dispute resolution. Mediation before litigation, and a mechanism for breaking deadlock.

Should you be a partnership at all

For most trading businesses, the honest answer is no. The reason is liability. In a partnership, if your partner signs a bad contract, hires the wrong person or makes a serious mistake in the ordinary course of the business, the creditor or claimant can come after you personally, and after everything you own. Nothing in your partnership agreement changes that as against the outside world. It only gives you a right of indemnity against your partner, which is worth exactly as much as your partner is worth.

A company gives you a separate legal entity and confines that risk. See setting up a business for the comparison, and shareholders agreements for the equivalent document.

Partnerships still make sense in some settings: professional practices where a partnership is the traditional or required form, joint ventures with a defined end point, and family arrangements where the tax treatment is the driver. In those cases, the agreement carries more weight, not less, because it is doing all the work the corporate form would otherwise do.

Getting out of a partnership that has gone wrong

Partnership disputes are unusually bitter because the parties are jointly liable and often related. The practical sequence is this.

First, establish what kind of partnership you have. A partnership for a fixed term ends at the end of it. A partnership at will can be dissolved by notice, which is a powerful and dangerous lever. Second, secure the records. Partnership accounts, bank access and client lists disappear quickly once a dispute starts. Third, deal with the bank and the creditors, because dissolution between partners does not release either of you from a joint debt.

On dissolution, the assets are applied to pay the firm's debts, then to repay partners' advances, then capital, then any surplus is divided in the profit sharing proportions. Where one partner wants to continue the business, the usual outcome is a negotiated buy-out rather than a fire sale, and the argument is about valuation and about goodwill. Get advice before you serve any notice, because the wrong notice can dissolve a business you wanted to keep.