Partnerships
The second business model
A partnership is a business marriage of sorts, with many of the advantages and disadvantages of the sole proprietorship.
Personalities are an inherent part of the equation in the success or failure of the venture, and thus the business can become ‘personal’ in ways not contemplated when the partnership was formed.
The many partnership jokes and anecdotes illustrate that when a partnership goes wrong, it’s more than the business which is at risk: it’s the relationship as well.
Knowledgeable and informed advice from a lawyer with proven business experience can be of great benefit to both.
First things first: Advantages and Disadvantages
Primarily, partners provide someone with whom each owner can share responsibilities, decisions and financing. They might have complementary and unique skill sets that give the business a clear advantage: one partner, for example, might have the specific and required technical skills while the other has a business background.
It’s relatively easy to fill out the government forms, choose a name, split the small fee and create the partnership. Similar to sole proprietorships, partners pay only their personal income tax and retain full profit since there are no corporate taxes involved.
The main disadvantage, as per a sole proprietorship, is that the partners are legally responsible for all aspects of their business: they can be found liable and sued. Personal finances, bank accounts and family homes are all vulnerable. It is little comfort that there is someone to share this devastation; worse, one partner might blame the other.
Consider a ‘Prenup’ Partnership Agreement
In addition to taking steps to minimize your exposure to such liability, there are other significant decisions that prospective partners should consider. Resolving these matters when the business is formed can save aggravation and expense later. Consider it a sort of “prenup’ for business.
As part of such an agreement, Howard Nightingale offers these services:
- Advise and obtain instructions.
- Create partnership agreement, including any revisions.
- Create dissolution agreements, partnership agreements and business registrations.
Will the Partnership be General or Limited?
These are two variations of the partnership arrangement, and they can significantly alter it. The general partnership with its 50/50 agreement is the familiar one. However, the limited variation identifies one person as the controlling partner who will bear the major responsibility for debt and contractual obligations, while the remaining partner’s exposure is limited to his or her investment or holdings in the partnership. Profits, therefore, might not be equal, and the controlling partner can be more vulnerable in a lawsuit.
Some considerations for dissolution agreements
- Setting the terms for the dissolution of the company.
- Resolving the issue of selling to a third party.
- Resolving the issue of the right of first refusal.
- Considering how the selling partner’s share will be valued.
- Considering terms of buyout financing.
Why You Need a Dissolution Agreement: A Real-Life Scenario
Partner A wished to sell; however, with no dissolution agreement in place the partners could not agree on anything, including value and financing. Eventually, partner A found an interested third partner willing to buy him out but partner B objected to being in business with a stranger. Both were legitimate points of view which unfortunately conflicted with each other. Eventually their friendship turned to rancor; they ended up not speaking to one another and the workplace environment became poisonous. It took years and a great deal of legal expense to finally resolve the issue.
The time for discussion of these issues is when the partnership is being established. This is where the advice and guidance of a lawyer skilled in such business contracts is not only invaluable, but just might preserve a life-long friendship.
Frequently Asked Questions
Dissolution involves more than just walking away. You must settle all partnership debts, distribute remaining assets, file a final tax return, and file a “Declaration of Dissolution” with the Ontario Business Registry to ensure you are no longer legally tied to future liabilities of the firm.
In Ontario, LLPs are generally restricted to certain professions like Lawyers and Accountants. It protects individual partners from personal liability for the negligence or malpractice of their partners, though they remain liable for general business debts.
Without an agreement, a partner leaving can trigger a mandatory winding up of the business. An agreement allows for a “Buy-Sell” arrangement where the remaining partners have the first right to purchase the departing partner’s interest based on a pre-set valuation formula.
If you are 50/50 partners and cannot agree, the business can paralyze. A professionally drafted Partnership Agreement includes “Dispute Resolution” clauses, such as mandatory mediation or a “Shotgun Clause,” which allows one partner to buy out the other at a set price to break the stalemate.
Yes. In fact, many sophisticated business structures involve two corporations forming a partnership. This allows the business to benefit from the flow-through tax nature of a partnership while providing the owners with the “corporate veil” of liability protection.
A partnership does not pay income tax itself. Instead, the business’s profits or losses “flow through” to the partners. Each partner reports their share of the income on their personal T1 tax return. This can be beneficial if the business has early losses that you can use to offset other personal income.
An LP consists of at least one “General Partner” (who has unlimited liability and manages the business) and one or more “Limited Partners.” Limited partners are typically investors; they have limited liability up to the amount they invested, but they are legally forbidden from participating in the daily management of the company.
While not legally required to start, it is highly dangerous to operate without one. Without a written agreement, the Ontario Partnerships Act dictates your rules. This means profits must be split 50/50 even if one partner does more work, and the death or exit of one partner could legally force the entire business to dissolve immediately.
This is the most significant risk in a partnership. It means that if your partner signs a bad contract or causes legal damage, a creditor can sue you for the full amount, even if you had nothing to do with the specific incident. Your personal assets are fully exposed to the actions of your partners.
A General Partnership is formed when two or more people carry on a business together with the intent to make a profit. Unlike a corporation, it is not a separate legal entity. Partners share equally in the management, profits, and, most importantly, the unlimited personal liability of the business.
Your information will always remain private and confidential.