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Forming a Partnership

Forming a Partnership

Karen G. Shin September 1, 2010

 

If you’re involved in a business venture or plan to start a small business with someone else, you might be thinking about forming a partnership. (There are also other ways to run a business. Refer to the posting titled “Starting a Small Business” to find out more about the alternatives before deciding on a partnership.)

What is a partnership?

 

A partnership is formed when two or more people – or companies, for that matter – agree to carry on a business together and share its profits and losses. Whether or not you are actually profitable doesn’t matter. What counts is forming a business together with the intention of making a profit.

BC’s Partnership Act sets out the rules for partnerships

 

These rules apply automatically to all partnerships. If you choose to be involved in a partnership, you may want to change some of these rules by making a written partnership agreement. Partnership agreements are discussed toward the end of this script.

Are there different types of partnerships?

The Partnership Act talks about three types:

  • general partnerships
  • limited partnerships
  • limited liability partnerships

Most small business partners are partners in a general partnership

To understand how a general partnership operates, say you and your friend Bill Smith want to open a store and be partners. You would both be equal partners. The law presumes that, as partners, you and Smith would share equally in the profits and losses of the partnership business, unless you have a partnership agreement that sets out a different arrangement. And you would both have the right to be involved in managing the partnership.

Is a partner responsible for the general partnership’s debts?

 

Yes. General partners are each personally responsible for the partnership’s debts. This is true whether or not you’re an active or inactive partner in the business.

Suppose you and Smith borrow $10,000 to set up your shop, but your business doesn’t do well and the partnership cannot repay the loan. Of course, the bank can ask that you and Smith pay back $5,000 each. But there’s also nothing to stop the bank from suing you alone for the whole $10,000. It would then be up to you to try to get Smith’s share from him. And if you don’t have enough cash to repay the debt, your personal assets – such as your house or car – could be taken, even though they have no connection with the business.

In a general partnership, each partner is personally liable for all of the obligations of the partnership, including any negligence of one of the partners.

 

Can any partner make decisions on behalf of the partnership?

 

Yes. Each general partner is an agent for both the partnership and the other partners. You and Smith can both make legally binding contracts on behalf of the partnership. So if Smith signs a contract with Jane Jones for supplies for the partnership business, you, Smith and the partnership each have to fulfill the contract, whether you agree with it or not.

 

And any partnership agreement between you and Smith cannot limit your responsibility to individuals who innocently sign a deal with Smith, believing he is authorized to act on behalf of the partnership.

General partners must act in good faith

 

General partners owe a duty to each other to act with utmost good faith and fairness. You have to give each other full information on matters affecting the partnership. You can’t take advantage of something that belongs to the partnership without your partners’ permission, such as using the partnership’s business connections to set up a competing business on the side. And you can’t take a personal benefit from any transaction involving the partnership – like taking kickbacks from suppliers.

It’s important to choose your partners carefully

 

You should only be partners with people you trust and have confidence in.

It’s best to have a partnership agreement

 

A carefully drafted agreement can be a very useful planning tool and help your partnership run smoothly. It can cover certain things like the following:

  • Will you share the profits 50/50? What if one of you puts up more money at the beginning than the other?
  • Will you also share equally in the losses?
  • Who will manage the business? (If you’re going to run the store and expect to get paid a salary, this should be included in your agreement or in a separate employment agreement.)
  • How much money will each partner contribute, and when will it have to be paid?
  • How will decisions be made? By majority vote, or unanimous decision? (You could agree to make some decisions one way, and other decisions another way.)
  • How will new partners be brought into the business, and how can you get rid of a partner or leave the partnership if you have to?
  • How will you end the partnership when the time comes, and who’ll get what?
  • What happens when a partner doesn’t live up to his or her obligations?

 

It’s true that verbal partnership agreements or “hand shake” agreements may be enforceable. But partnership agreement should be in writing, so you can prove what the terms of the agreement are.

 

Does a partnership have to be registered?

 

Limited partnerships and LLP’s must be registered with the Registrar of Companies to exist. The Partnership Act contains a list of the documents that must be filed or submitted to create these partnerships. A general partnership should be registered, but it will still exist even if you don’t register it.

You should make sure that you let the Registrar know if any information on your registration changes (for example, if a partner joins or leaves, or if your address changes).

 

You have to pay a fee to register your partnership with the Registrar of Companies and to have the Registrar search the corporate records to make sure someone else isn’t already using your partnership name. Depending on the type of partnership, procedures must be followed regarding the use of the partnership name and address. If your partnership is for trading, manufacturing or mining purposes, or is a limited partnership or a limited liability partnership, you also have to file other information and documents with the provincial government.

Consider seeing a lawyer

Before making a partnership agreement, it’s best to hire a lawyer to help you. Also, limited liability partnerships and limited partnerships are usually quite complicated, so you typically need the assistance of a lawyer to set them up.

What income tax does a partnership have to pay?

The good news is that a partnership doesn’t have to pay any income tax on its profits. Unfortunately, there is the usual bad news – each partner has to pay income tax on his or her share of partnership profits. Likewise, if a partnership business loses money, the losses are divided among the partners in the same way as profits would have been, and for income tax purposes, are treated as though each partner had lost that amount of money running his or her own business.

 

Before setting up a partnership, in addition to consulting a lawyer, you should obtain some income tax advice from a qualified professional.

 

Where can you get more information?

 

 

  • You can obtain a copy of BC’s Partnership Act from any bookstore that sells government publications or download a copy from www.qp.gov.bc.ca/statreg.
  • Small Business BC is a government resource centre with excellent information and free guides. Call 604.775.5525 in Vancouver or 1.800.667.2272 elsewhere in the province, or visit www.smallbusinessbc.ca.
  • Also see the Resource Centre for Small Business on the Ministry of Small Business and Revenue’s website at www.gov.bc.ca/sbr.

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