Before starting a partnership – read this!
Going into partnership can be an exciting time! Before you or your clients rush in, here are a few essential questions to ask yourself.
1. Do you have the right structure?
People often loosely use the word “partnership” but, as you may know, there are various structures available to people who want to go into business together. For example, other popular business structures are companies and trusts.
Each structure will have its pros and cons. Lawyers can advise about asset protection (so that houses are not lost in the event the trading entity is sued) and succession issues (so that Wills are updated to cover the new entity). Accountants can advise on taxation treatment of each of the options.
Partnerships with individuals are simple and cheap to set up and administer. However, one downside is that all partners are “jointly and severally” liable for the debts and liabilities of the business. This means that the partners together, and individually, are on the hook.
So one partner could wind up paying for a debt the other partner incurred! Taxation wise, individual partners pay tax at their personal tax rates and there is no flexibility on who receives the income. It is possible to have a partnership of trusts to lessen this risk. Ideally with corporate trustees.
2. Do you have a partnership agreement?
Going into business with other people is like entering into a “commercial marriage”. It is a serious commitment and, although things may seem peachy right now, unforeseen events could arise which may end the honeymoon early. What happens if the partners do not agree on something? How will decisions be made? What happens if one partner goes through a divorce – will someone end up in partnership with their partner’s spouse instead? What if someone falls ill or passes away? What if someone can no longer contribute what they promised to at the start?
All of these considerations can be dealt with in a legally binding agreement – such as a Partnership Agreement, Shareholders Agreement or the like (depending on the structure you are using), which a lawyer can assist with. This process may be a lot less expensive than dealing with a problem down the track.
3. Have you considered insurance?
A financial planner should be consulted about ensuring the partners are covered by the appropriate insurance, should the business entity get sued or something else unforeseen occur.
Apart from business insurance, the partners could also consider having life insurance and insurance for trauma or total permanent disability. A Critical Event Agreement can put measures in place so that such an insurance pay-out covers the cost of a partner’s interest if one of these events occurs. For example, if one partner dies, a life insurance pay-out could be set up to go to this partner’s grieving spouse while the surviving partners then automatically take over the business without having to come up with money to pay out the spouse. It is not enough to take out the insurance, but a legal agreement needs to be put in place to ensure what you want to happen does happen in such events.
4. Have you considered leases, business names, patents, council approvals etc?
Business owners need to ensure that they can legally operate the business from their business premises and are protected from the possibility of others “stealing” their idea or closing them down. Legal advice should also be sought if a lease is being signed so that the tenant knows their rights and obligations there.
Starting a partnership can be an exciting and rewarding venture. Before you or your clients say “I do” though, make sure the intending partners are fully informed of their options and have the correct measures in place to avoid detriment in the future. Contact us for more information.