In the last tutorial in this series, we looked at one of the four main business structures in Australia – the Sole Trader structure. Now it’s time to look at another business structure – the Partnership.
But before we go any further, I need to remind you that any information presented on this blog is solely for informational purposes only. I make no guarantee that any of the information on this blog is accurate or complete. I cannot be held responsible for any loss or damage caused by reliance on any of the information or advice provided on this blog. If you are serious about your business, please consult a solicitor, accountant, or business consultant for advice. This blog is NOT LEGAL ADVICE! Any use of the information here is SOLELY at your own risk. For more information about this, please read my disclaimer.
If you need a quick recap on what “business structure” actually means (and why it’s legally imperative!), make sure you take a look at my previous tutorial in this series. Then, once you’re ready, it’s time to look at Partnerships!
In many ways, a Partnership is similar – but the difference is that TWO or more people TOGETHER are the business. This is both the main strength, AND the main weakness.
The way the law likes to define a Partnership is “the relationship which subsists between persons carrying on a business in common with a view to a profit”. So in other words, YOU ALL own the business, YOU ALL are directly in control of everything, and all money the business makes belongs to ALL OF YOU JOINTLY (although all of these things can be modified somewhat through the use of a Partnership Agreement … more on that later).
But remember – just like with the Sole Trader business structure, with a Partnership the business is NOT a separate legal entity either (although from an accounting point of view you’ll want to treat your finances from your business separately from your other income, otherwise it just gets too messy).
Limits of a Partnership
By law, the size of a Partnership is not unlimited. Generally speaking, a Partnership is limited to between 2 and 20 partners. However, there are some interesting (and bizarre!) exceptions.
For example, according to the Corporations Regulations 2001 (Cth), a Partnership can consist of:
- 50 actuaries, medical practitioners, patent attorneys, sharebrokers, stockbrokers or trademark attorneys;
- 100 Architects, pharmaceutical chemists or veterinary surgeons;
- 400 legal practitioners (God help us all …)
- 1,000 accountants (need I say more …)
Now, let’s look at some of the advantages and disadvantages of setting up a business as a Partnership.
Advantages of a Partnership
Starting business as a Partnership can be almost as simple as starting off as a Sole Trader. Both these structures are the simplest ways to structure your business.
Advantages of forming a Partnership include:
- It’s relatively easy to set up (I’ll tell you how shortly)
- There is less paperwork (in comparison to business structures like Trusts and Companies)
- It’s inexpensive
- There is less government interference and regulation (at least in comparison to a Company)
- It offers more privacy (in comparison to the reporting requirements of a Company)
- There is less need for hiring lawyers, accountants, and other consultants (at least in comparison to a Trust or Company)
- There is a broader management base (compared to that of a Sole Trader), which also means a wider pool of expertise, shared risk (which can be both good and bad…) and more sources of capital
- There may be tax planning advantages (such as income splitting)
Obviously, the above are broad generalisations, but they should give you a good idea of why some people choose this business structure.
And just like a Sole Trader, in a Partnership you can still employ people (NOT partners though – partners CANNOT be employees of the business), engage other contractors, apply for financing (although this last part might be more difficult compared to a Company), and do many other things. Again, there is a lot you can do.
So, what’s the catch, I hear you say?
Disadvantages of a Partnership
Interestingly enough, the main strength of the Partnership structure (eg. having more than one person in control of the business) is probably also the main weakness!
Why? Well, each and every one of you (as partners) has control of the business. This also means that each one of you is an “agent” for the business. This is where the law of “agency” can become an issue.
Since all of you have authority as joint owners, each one of you can contract with a third party (without the knowledge of any of the other partners), and you will ALL then be bound to that contract, regardless whether the partner in question actually had the permission of the other partners.
Naturally, this means that each and every one of you face the very real prospect of becoming personally liable for a bad business decision made by any one of the other partners (even if you didn’t know about it!). In fact, one of the “features” of a Partnership is that all partners are “jointly and severally liable” for all debts and liabilities incurred by the business. A Partnership can, of course, make it easier to pay off such debts, since all partners take a share of this risk.
But what if we take the example mentioned earlier even further … what if one of the partners decides to pack it in, clean out the assets of the business, and then flee to Majorca? Well, that’s too bad for you and the other partners. The Partnership will still have all its liabilities to pay off, and the remaining partners will be liable to pay off your scumbag partner’s share of the debts too (unless you are able to track down and sue the absconding partner for his/her share of the debts).
And if we take this example EVEN further (please let me indulge myself here…), if your remaining partners decide to follow the excellent example set by the partner now living up the high life in Majorca, you will then be left holding the ball. Since as a partner you are jointly and severally liable, this now means that you will become personally liable for ALL the debts and liabilities of the entire Partnership (unless you can track down the other partners and sue them for their share of the problems)!
Anyone who wants to sue the Partnership won’t care where the other partners are, and they are under no obligation to follow that up. They can sue whoever they want – and they will probably sue the person who is easiest to get to. In other words, all partners are “jointly and severally liable” for any debts or liabilities the Partnership incurs. And, just like the Sole Trader business structure, as a partner in a Partnership you have unlimited personal liability if anything goes wrong with the business.
In fairness, the above situation can be controlled (to a limited extent) with appropriate insurance cover. Additionally, you CAN actually avoid personal liability altogether in a Partnership by becoming a limited partner. But more on that shortly.
Other disadvantages of forming a Partnership include:
- Lack of continuity
- Divided authority (can be a good thing or a bad thing)
- Friction between partners, personality clashes, etc
- Limitations on size (generally speaking the maximum number of partners in a Partnership is 20, but with some exceptions …)
- Bankruptcy or death ends a partnership. Partnership must then be re-formed (which incurs costs, paperwork, and lots of time …)
- If a partner absconds or dies, other partners are left with that partner’s debts and liabilities (as discussed above)
- Transfer of ownership is difficult
- Adding partners is difficult – generally requires the agreement of all partners
- If a partner decides to dissolve a business, it may bring the Partnership to an end
- If a partner wants to join or leave, all the partnership assets, etc may need to be valued (which is costly and time-consuming!)
Looking at the list above probably makes a Partnership seem like a very unappealing proposition. But it doesn’t have to be, and ESPECIALLY if you consider what is at the crux of most of the above negative points – a combination of lack of organisation, lack of communication, and – consequently – lack of trust.
A Partnership Agreement can be used to counter many of the above disadvantages, or at least make provision for what should happen if certain scenarios ever arise. More on Partnership Agreements shortly.
For the most part, this entire tutorial deals with Partnerships consisting of what the law calls “general partners”.
There is, however, provision to set up an alternative form of Partnership called a “Limited Partnership”. Unlike a general Partnership (which I have simply referred to as “Partnership” throughout this tutorial), a limited Partnership actually needs to be separately registered with your State’s Fair Trading Office/Business & Consumer Affairs department (almost every State/territory calls it something else, and it’s not uncommon for them to rename it every few years…).
A limited Partnership must consist of at least one general partner, and one limited partner. A Partnership (of any kind) can only have a certain maximum number of general partners in the business (which I will discuss shortly), but there are NO limits to the number of limited partners that can be involved in a limited Partnership.
To recap the differences between a general partner and a limited partner: a general partner is simply the type of partner I have referred to throughout this tutorial. Basically, a general partner is a full partner in the Partnership, and hence has managerial control and authority to act on behalf of the business. A general partner also has the personal liability issues mentioned earlier.
A limited partner, however, does not have such powers, or liabilities. A limited partner cannot take part in the management of the business, and generally has no authority to act on its behalf (although some of these things can be modified to an extent with a Partnership Agreement). But, more importantly, a limited partner has LIMITED liability (which counters a lot of the disadvantages mentioned earlier).
So, why would anyone consider a limited Partnership then?
For the most part, limited Partnerships are useful in situations where potential partners simply want to contribute capital and share in the success of the business (but without having control or authority in the business). In many ways, a limited partner is more like a passive investor in the business. They take a risk in providing the business with capital (eg. to help launch or grow the business), but if things go wrong they do not have the liability associated with general partners. If they did, this would not encourage investment!
The above is a really simplified explanation of limited Partnerships, but it hopefully gives you a general (or should that be “limited” – woohoo, lame pun!) idea of what limited Partnerships are.
There is also a more complex version of this kind of Partnership called an “Incorporated Limited Partnership” (where the Partnership actually becomes a separate legal entity like a Company), but I will not discuss that here. Anyone considering such an advanced structure will generally be doing so because they are considering a joint venture with another business (or businesses). And if that’s the case, you really should be arranging appointments with lawyers, accountants, and other business advisors right now!
It is nice to think that your word alone is good enough to form the trust required to run a Partnership. But let’s face it – a written document that CLEARLY outlines all important aspects in this sort of relationship will ALWAYS be a better option. It’s a simple risk management strategy. Remember – statistically, there is a STRONG possibility that something will eventually go wrong. And when that happens, you’ll be kicking yourself if you didn’t have that initial agreement set down on paper!
So think of a Partnership Agreement as a form of a protection … a form of insurance for ALL of you in the Partnership.
Yes, drafting a good Partnership Agreement DOES take time. It will also most likely require the services of a lawyer (did I just hear you groan …?) or other business consultant. So it will probably also cost a bit to get right. You DON’T have to use the services of a lawyer, etc to draft a Partnership Agreement – but since it will probably be used in some sort of legal context eventually, it’s probably a good idea to use a lawyer from the very start.
Remember, though, that a Partnership Agreement isn’t actually compulsory (unless you’re forming an Incorporated Limited Partnership – which I am not covering in this tutorial). Should you wish to proceed without a Partnership Agreement, then you can.
HOWEVER, realise that in the absence of a written Partnership Agreement, the law will consider you all to be EQUAL partners in the business (both from a management perspective, and also from a profit/loss and liability perspective). This might become especially problematic if profits are to be distributed in a certain way that isn’t intended to be equal.
So, what sorts of things can be included in a Partnership Agreement?
Elements of a Partnership Agreement
A typical Partnership Agreement may include some of the following key items:
- Names and addresses of all partners
- Nature and purpose of the Partnership business
- Name of the Partnership business
- Business address
- Start date and duration of the Partnership
- Capital to be contributed to the Partnership by each partner
- How profits and losses will be shared among the partners
- Arrangements for Partnership salaries/drawings/income
- Managerial roles of each partner
- Any limitations on the authority of each partner in making decisions or signing financial and legal documents
- How decisions will be made by the Partnership
- Agreement to engage certain consultants, such as a lawyer, accountant, or other business advisor in certain matters
- Accounting details for the Partnership
- Details of bank accounts for the Partnership
- Provisions for the death, bankruptcy, or retirement of a partner
- Provisions under which partners can change or assign their interest in the Partnership
- Provisions for dispute resolution between partners
- Provisions for the addition of new partners
- Provisions for the dissolution of the Partnership (including the method of valuation and distribution of assets, etc)
The above is a summary of some of the key elements a Partnership Agreement should contain. Again, it is advisable to seek the services of a professional to assist with drafting such an important document. The last thing you want to find out when the proverbial hits the fan is that your Partnership Agreement has missed a key item, or is completely invalid from a legal point of view!
Should I Set Up My Business As a Partnership?
Obviously, only you and your potential partners can know that. I cannot advise you on what YOU should do. This tutorial is not intended as a full guide to the features of operating a Partnership, but hopefully it gives you some idea about what to look out for.
Additionally, WHO you partner with will be crucial. You need to approach this with your sharpest business mind, and base your decision on more than just “friendship”. There are many examples of friends falling out soon after setting up a Partnership. Some of this might simply be attributed to a lack of thought and discussion between the partners beforehand. They may have just assumed that since they are friends and get along, that this will automatically transfer to the serious business relationship that is a Partnership. But it generally won’t. A Partnership is a completely different type of relationship.
So basically you need to TRUST your partners, and you need to be on the “same page” regarding your goals for the business. Sounds simple, but it is often overlooked in the rush of enthusiasm at the beginning. Remember – running a business properly is a hard slog.
If, however, you CAN find partners to work with that you can trust, and that you have had serious discussions with about forming a Partnership, then you also need to make sure that the advantages of setting up as a Partnership outweigh both the disadvantages, and also the advantages of running other business structures (eg. such as a Company).
There are, no doubt, other issues you will probably need to ponder too (depending on your individual circumstances and also the industry you want to operate in). But hopefully the above gives you a useful starting point.
So, How Do I Set Up a Partnership Then?
First of all, you need to decide if you want to run the Partnership business under just the names of all the partners (eg. “Adam Wozniak, John Smith, John Citizen, Joe Cool, and Joe Sixpack”), or whether you want an actual business name (eg. “Super Duper Abracadabra Solutions”…).
If you want to run your business under the personal names of all the partners (with NO other additions), all you need to register for is an Australian Business Number (ABN) for the actual Partnership (eg. one ABN for ALL the partners together, rather than individual ABNs like you would have as a Sole Trader).
APPLYING FOR an Australian Business Number (ABN) for the Partnership
Regardless of whether you decide to run the Partnership business using the personal names of all the partners, or whether you register a business name, you will still need to obtain an Australian Business Number (ABN) for the Partnership.
To obtain an ABN, you will need to apply for it through the ATO. Thankfully, these days you can obtain an ABN in about 30 minutes without even leaving your computer. Click here to apply for an ABN. But just make sure you and your partners have agreed on how you will fill out these types of applications.
APPLYING FOR a Partnership Tax File Number (TFN)
The Partnership will also need its OWN Business Tax File Number (TFN) – unlike a Sole Trader, who uses his/her own personal TFN.
For the Partnership, this means that all partners will still have their own personal TFN for their own personal individual income tax return, but the Partnership as a whole will have its own TFN on top of that. Yes, this means that in addition to lodging your own personal tax return, the Partnership itself will have to lodge its own, separate tax return too. Woohoo!
But note that a Partnership in itself is not liable to pay income tax or PAYG installments. Instead, the individual income (and share of profits/losses) you, as a partner, make from the Partnership will need to be included in your own personal income tax return. THAT is how tax is paid on income generated by the Partnership.
So to reiterate – the Partnership itself does NOT get taxed, and that’s because it is NOT a separate legal entity (unlike a Company business structure).
That means that come tax time any income you make through your Partnership is counted together with your own personal individual income (so that means it is lumped in with income you make from other sources too – such as a job you might have on the side). By default, the law will assume that all Partnership income/profits/losses will be split equally among all partners, but it doesn’t necessarily have to be so. This is one of many areas where a proper Partnership Agreement can be useful, as mentioned earlier.
To obtain a Business TFN for your Partnership, you can do it online while you are applying for the ABN. Click here to apply for a Business TFN. Again, make sure you and your partners have agreed on how you will fill out these types of applications.
Registering a Business Name
If you want to operate under an actual business name (rather than the personal names of all the partners), then you MUST register the business name
in your particular State.
UPDATE: In May 2012, a new national business names system commenced, replacing the old State system. This actually makes the process easier (and cheaper) than ever. The administration of all business names Australia-wide is now handled by the Australian Securities & Investments Commission (ASIC). To begin the business name registration process, just click here.
If you intend on operating your business in multiple States, then you will need to register your business name in every State where your business will be operating. Registering a business name in one State generally costs about $150 for 3 years. Naturally, if you intend on registering in more than one State, these costs will begin to add up quickly. To find out more about the costs and paperwork required, please visit the relevant State office and look for “Business Names”: Australian Capital Territory – Office of Regulatory Services New South Wales – Office of Fair Trading Northern Territory – Department of Justice Queensland – Department of Employment, Economic Development and Innovation South Australia – Office of Consumer and Business Affairs Tasmania – Consumer Affairs and Fair Trading Victoria – Consumer Affairs Victoria Western Australia – Department of Commerce
Some notes to remember about registering a business name though:
- You can’t register a business name that is already registered in your State
- You can’t register a business name that is already taken as the name of a registered Company
- You can’t register a business name that is already registered as a Trademark (eg. “Coca-Cola”, “Google”, etc)
- Even if the business name partly contains the personal names of some of the partners, you STILL NEED TO REGISTER A BUSINESS NAME. Eg. although you wouldn’t have to register “Adam Wozniak, John Smith, John Citizen, Joe Cool, and Joe Sixpack”, if you decided to call the business something like “Wozniak and Partners”, then you MUST register a business name. This is the part that MANY people get wrong!
- Registering a business name is more about consumer protection than it is about protection for your business. In other words, registering a business name does not, in itself, necessarily give you any legal rights to your business name. It gives you less rights than registering your business as a Company, and it gives you even less rights than registering your business name as a Trademark. Basically, a business name has NO legal status in itself.
Despite all of this, registering a business name can be very quick and affordable. And there is a LOT less paperwork required compared to other business structures (such as a Company).
Once you have obtained an ABN, Business TFN, and registered your business name (if applicable), you need to ensure that the Partnership ABN is actually linked to the business name. By default, it might not be. To link the Partnership ABN to the business name, telephone the ATO on 13 28 66.
What if I Don’t Want to Operate as a Partnership?
So those are the basics of structuring a business as a Partnership in Australia. Naturally, it’s important that you also consider the merits of the other three major business structures (and especially if registering as a Partnership does not appeal to you – it’s definitely not for everybody!). It’s important that you consider your options carefully.
Remember, selecting a business structure is NOT an optional step if you want to ensure your business has been set up PROPERLY and LEGALLY. Some groundwork now will save you a whole lot of potential headaches in future. Besides, having a business structure makes your business look more professional and reputable.
In the next tutorial in this series, we will be looking at another type of business structure – Trusts (a structure which holds property in trust for its beneficiaries). If you’re interested in reading about the Sole Trader business structure instead, then make sure you check out the previous Sole Trader tutorial.
UPDATE: Please note that due to an overwhelming number of email enquiries and blog comments over time, I’ve had to disable all contact methods. I am unable to offer any further assistance or advice. If the above article hasn’t answered all your questions, I encourage you to look through the archived comments below. You’ll find frequently asked questions there. Thanks.