Partnership agreement explained: how a partnership forms and what to include (UK)

If you are thinking about going into business with someone else, a partnership agreement is the document that turns a loose arrangement into a robust, legal partnership. The reason it matters so much is that a general partnership forms automatically, without any paperwork, and if you have not agreed your own terms you are stuck with the ones the law gives you. This article explains how a general partnership comes into existence, what every partnership agreement should contain and why I recommend one to anyone going into business with another person.

What is a partnership?

A partnership is a business relationship where two or more persons come together with a view to making a profit and carry on a business together. That is the whole definition.

There are three main kinds of partnership in the UK: the general partnership, the limited partnership and the limited liability partnership. The differences between them are explained in what is a partnership. This article focuses on the general partnership, because it is the one most people end up in.

How is a general partnership formed?

This is the point that surprises people. A general partnership is formed automatically as soon as the definition of a partnership is met. So long as there are two or more persons who come together to carry on a business with a view to making a profit, a partnership exists.

There are no fees to pay. There are no forms to fill out. There is nothing to register. That is exactly why some people do not even know that they are part of a partnership. Two friends who start selling something together, splitting the costs and the takings, are partners in the eyes of the law whether or not they have ever used the word.

Because the partnership exists whether you plan it or not, my practice always recommends that anyone looking to get into a business with another person has a strong and legally binding partnership agreement in place. The agreement does not create the partnership. It sets the terms of the partnership that already exists, or is about to.

What to include in a partnership agreement

A partnership agreement helps you identify and clarify the expectations of each of the partners. Every partnership is different, but there are certain elements that should be in every partnership agreement.

• The duties of each partner. Identify exactly what each partner is responsible for. Who runs which part of the business, who deals with customers, who manages the money. Spelling this out avoids the argument about who was supposed to be doing what.
• Capital contributions. Specify how much capital each of the partners is to contribute to the business. This is the amount each partner is putting in, and it is often the starting point for how everything else is shared.
• How profits are distributed. State whether profits are shared equally or, for example, in proportion to the amount of capital that each partner has invested. If one partner has put in far more than the other, an equal split may not be what either of you intended.
• How much liability each partner takes on. Specify how the liabilities of the business are allocated between the partners, so that everyone knows what they are exposed to.
• What happens if a partner wants to leave or dies. Set out the exit provisions. A partner may want to retire, move on to something else, or may pass away. The agreement should say what happens to their share and how the remaining partners carry on.

These five points are the minimum. A well-drafted agreement will deal with other matters particular to your business, but if these five are missing the agreement is not doing its job.

Why you need a partnership agreement

A partnership agreement brings certainty. Each partner knows what they have committed to, what they are entitled to and what happens when circumstances change. That certainty minimises the risk of disputes arising, and in my experience disputes between partners are the thing most likely to damage an otherwise good business.

Without an agreement, none of this is settled. You are relying on default rules that were not written with your business in mind, and on everyone remembering the same version of a conversation you had before you started.

If you want to avoid issues and you are getting into a partnership, make sure to have a partnership agreement in place that was professionally drafted by a solicitor. A template pulled from the internet will not reflect your duties, your contributions or your exit arrangements, and those are precisely the points that cause trouble.

Next steps

Before you start trading with a business partner, agree the five essentials: duties, capital contributions, profit sharing, liability and what happens when a partner leaves. Then have those terms put into a legally binding partnership agreement by a solicitor, so that both of you are working from the same document rather than the same memory.