Before you embark on a business venture, you should consider the most appropriate type of business structure to put in place to operate that business venture. That is, will you operate the business just by yourself (as a sole trader), in partnership with other individuals or companies (called a partnership), or will you set up a more complex company or trust structure?
Each business structure has different advantages and disadvantages.
This article looks at partnerships – how to set one up, and the pros and cons of the partnership arrangement. This article is the second in a series about business structures (see part one here).
A partnership is formed where 2 or more people carry on a business as partners and distribute income and losses between themselves.
The key features of a partnership are:
- All of the partners own the business (including all assets of the business) jointly.
- All of the partners control the operation of the business jointly.
- All of the partners receive all of the profits of the business jointly.
- There is no separate legal entity (like with a company), and therefore, there is no limitation on your personal liability, such as is offered by a company.
How to set up a partnership
A partnership is one of the simplest ways to structure a business and is relatively easy to set up.
Most partnerships are established by a partnership agreement which sets out the rights and obligations of the partners. Although a partnership agreement is not essential, it is a very important tool to have in place to minimise the potential for misunderstandings or disputes between you and your partner/s.
A partnership can be run under the personal names of all the partners or under a business name. If a business name is to be used, then it must be registered with ASIC. You can find more information on how to register a business name here: https://asic.gov.au/for-business/registering-a-business-name/steps-to-register-your-business-name/
Regardless of whether a partnership is to be run in the names of the partners or a business name, a separate Australian Business Number (ABN) is required for the partnership. An ABN can be obtained online through the Australian Business Register by applying through the Australian Business Register website: https://www.abr.gov.au/business-super-funds-charities/applying-abn
A partnership also needs its own Tax File Number, which can also be obtained online from the Australian Taxation Office (ATO). Further information on how to apply for a tax file number for your partnership can be found here: https://www.ato.gov.au/Business/Registration/Work-out-which-registrations-you-need/Taxation-registrations/Tax-file-number/
A partnership must also be registered for GST if its annual turnover is $75,000 or more. Further information on how and when to register your partnership for GST can be found here: https://www.ato.gov.au/Business/GST/Registering-for-GST/
A partnership must file an annual tax return, but a partnership does not pay income tax. That is because it is not a separate legal entity. Instead, each partner pays tax on their share of the net income of the partnership.
Why have a partnership agreement?
A partnership agreement sets out and records important aspects of the partnership, such as:
- How much capital will each partner contribute to the venture?
- How will the profits be divided between the partners (especially where one partner is more “hands-on” with the business or has contributed more capital)?
- Who can make payments on behalf of the partnership?
- Can the partnership borrow money and incur debt on behalf of the partners?
- What happens if one partner no longer wants to be involved in the business?
- Who will be responsible for the day-to-day management of the business?
- If a dispute does arise, how will it be dealt with?
It is in all of the partners’ interests for there to be a written document which clearly sets out the important aspects of the partnership at the beginning of the business venture, to minimise the potential for disputes.
This is important because disputes between partners can not only destroy your relationship with your partners, but it can also reduce the profitability of your business.
Advantages and disadvantages of running your business as a partnership
The advantages of forming a partnership include:
- It is cheaper than some of the other business structures (eg a company) to set up;
- There are no formalities, registration or reporting obligations (other than tax returns);
- It is more private than trusts or companies; and
- It offers a broader management base, with a wider pool of expertise and capital than if you were to run the business as a sole trader.
The disadvantages of forming a partnership include:
- Unlimited liability for the partners, which means that the partners’ personal assets are exposed if the assets of the partnership are insufficient to pay any creditors;
- If a partner does not pay his or her share of the partnership’s liability, then the other partner/s must pay all of the partnership’s liability;
- Individual partners can be sued personally for anything done in the name of the partnership;
- There is a potential for disputes and loss of trust between the partners (as compared with a sole trader structure);
- Difficulties can arise where one partner no longer wants to be in the partnership; and
- There is a limitation on the maximum size of a partnership (generally the maximum number of partners is 20).
You should consider whether a partnership is the right business structure for you. If so, a partnership agreement should be put in place as soon as practicable so that each partner understands his or her rights and obligations to the partnership. This will minimise the potential for disputes later down the track.
If you or someone you know wants more information or would like help putting a partnership agreement in place, please contact us.