A business partnership is one of the most common types of business structures, alongside limited companies and sole traders. In this blog, we will consider the different kinds of business partnerships available and some of their key features.
What is a business partnership?
According to the Partnership Act 1890, a business partnership is: “the relation which subsists between persons carrying on a business in common with a view of profit.” What this basically means is that at least two ‘persons’ must be engaged in business together to be considered a business partnership. A person is usually an individual but it can also be a limited company.
All the partners are entitled to take part in business decisions and the overall management of the business partnerships. But each partner also needs to take responsibility for any acts or omissions of their fellow partners.
Profits and losses in business partnerships are generally shared out equally between all the partners unless agreed otherwise in a Partnership Agreement. Other than the case of limited partnerships and limited liability partnerships (LLPs), the partners are jointly or severally liable for all the debts and liabilities of the partnership.
Business partnerships are considered ‘tax transparent’. This means that no tax is payable by the partnership itself. Instead, each partner is accountable for paying their own individual income tax, according to their own profits and gains.
What are the different types of business partnerships?
Most business partnerships are ‘ordinary’ partnerships. Unlike the case of a limited company, an ordinary business partnership is not a separate legal entity. Instead of a company constitution, business partnerships will generally be governed by a partnership agreement. This agreement sets out the rights and responsibilities of each partner. It can also specify how profits are intended to be divided up and how important decisions are made.
The other popular type of business partnership is the limited liability partnership (LLP), which was introduced by the Limited Liability Partnerships Act 2000.
LLPs are a cross between ordinary partnerships and limited companies. An LLP needs to be registered as a company and is considered to be its own legal entity – one key difference compared to an ordinary business partnership.
The other main distinguishing feature is that the partners in an LLP, known as members, are not personally liable for any debts incurred by the partnership. However, LLPs are tax transparent and all the members are responsible for their own personal income tax.
In terms of its constitution, LLPs will normally have an LLP Agreement which sets out matters such as:
- Capital contribution of partners and profit share
- Management of partnership and decision-making process
- How to manage the exit of a partner
- Defining responsibilities of partners (to one another or to the LLP)
Although the Limited Liability Partnerships Regulations 2001 contain default provisions that govern certain aspects of running an LLP in the absence of an LLP Agreement, it is recommended to put one in place to minimise the possibility of disputes.
A much rarer form of business partnership, although one which has existed for much longer than LLPs, is the limited partnership.
This kind of partnership structure is more similar to an ordinary partnership in that it is not considered to be a separate legal entity.
Individual partners are responsible for entering into contracts on behalf of other partners. But it is possible to designate certain partners as ‘limited partners’ who do not take part in the management of the partnership and have limited liability for any debts incurred by the partnership.
Limited partners, also known as silent or sleeping partners, are typically investors who want to minimise their risks.
Partnerships vs LLPs
There are very few limited partnerships these days, and LLPs have essentially made them redundant. So the main choice when setting up a business partnership is whether to create an ordinary partnership or an LLP.
The main advantages of an ordinary partnership are:
- Simplicity – since it is not registered as a company, there is less administration and fewer costs of maintaining company accounts.
- Privacy – accounts do not need to be published or made publicly available, which may be beneficial if this information could be valuable to competitors, etc.
Disadvantages of an ordinary partnership include:
- Liability – all partners are personally liable for any debts incurred by the partnership.
- No legal personality – the partnership does not have its own legal personality, which means it is not considered a legal entity in its own right and therefore cannot trade or borrow money on its own account.
In terms of LLPs, some of the main advantages are:
- Limited liability – this is generally considered to be the main advantage compared with ordinary partnerships. The liability of partners is limited to the amount of their capital contribution.
- Legal status – incorporation means that the business has its own legal personality and can officially trade in its own name.
Some of the downsides of an LLP include:
- Admin – there are duties of running an incorporated company, such as ensuring that confirmation statements and accounts are submitted every year.
- Transparency – the accounts of an LLP must be filed with Companies House each year and therefore certain financial information will be in the public domain.
Business partnerships vs limited companies
Most businesses in the UK are sole traders. But as soon as two or more people want to get involved in a business venture, they will generally need to either set up a business partnership or a limited company.
Before LLPs were introduced, many businesses would traditionally become ordinary partnerships, such as the practices of lawyers and doctors. But many of these have since converted to LLPs, taking advantage of the hybrid model. Unless they want to introduce shareholders and gain investment without bringing in new business partners, there is now little need for LLPs to convert to limited companies.
There is still a considerable distinction between ordinary partnerships and limited companies, but LLPs offer a structure that has the best of both worlds.