Going into Business with Someone - What Should I Be Thinking About?

/ business services

The advantages of going into business with a partner are obvious – you can achieve much more as a team than as an individual, and complementary skillsets make for more effective performance.

But it can sometimes be easier to get divorced than to exit a business relationship without acrimony or financial loss. So, what should you bear in mind when contemplating a business partnership?

First – consider the form your business partnership will take. There are generally 3 options:

  1. a General Business Partnership (“GBP”);

  2. a Limited Liability Partnership (“LLP”); and

  3. a Limited Liability Company (“Company”).

General Business Partnership

It is possible to form a GBP without any formalities at all – as soon as you go into business with someone with a view to profit then you have formed a partnership, whether you intended to or not. Assuming that you do want to go into partnership, then it is always advisable to enter into a Partnership Agreement to establish who does what, who gets what, how new partners can be brought onboard, how the partnership can be brought to an end etc.. If you enter into partnership without a formal Partnership Agreement then the Partnership Act 1890 will dictate the terms of the partnership for you, so, even though some people feel that they are “keeping it informal” by not having a Partnership Agreement, they do in fact have a formal partnership agreement imposed by legislation, which may not actually reflect how they want the partnership to work.

A partnership requires no registration at Companies House, and its partners are treated as individuals for tax purposes, but its big disadvantage is that there is no limited liability for the partners. That means that if a claim is brought against the partnership (for example for negligence) then each partner is personally liable for that claim, so any successful claimant can pursue a partner for any asset he owns down to his last pair of socks (ok that’s not strictly true but a successful claim can certainly lead to personal bankruptcy if there is no adequate insurance cover to meet the claim). That unappetising prospect has lead to the creation of the………

Limited Liability Partnership

Created by the Limited Liability Partnerships Act of 2000 (the “LLPA”), these are a hybrid between a GBP and a Company. They require registration at Companies House, have similar filing requirements as companies in respect of filing annual accounts etc., and they have the very great advantage of having a separate legal personality from their partners (who are rather confusingly referred to as “members” in the LLPA). This means that, should someone successfully sue the LLP, the claimant can only proceed against the assets of the LLP and cannot seek to recover from the partners’ personal assets (including any amounts they may have received from the LLP). The members of LLPs are also taxed as individuals on the same basis as if they were partners in a GBP. The great advantage of the LLP having a separate legal personality is the reason why almost all law firms and accounting firms have long since converted to LLP status.

As with a General Business Partnership, you would be well-advised to have a Limited Liability Partnership Agreement in place before you register the LLP at Companies House because, just like for the GBP, if you don’t, the legislation will impose one for you, whether you like it or not.

Limited Liability Company

The third, and most popular option, is to set up a Company. These have the advantage of a separate legal personality (it is possible to have an unlimited company but these are almost now extinct since they have no clear advantage other than the ability to avoid publishing accounts) and require registration at Companies House, and annual filing of accounts and annual statements detailing the shareholdings in the Company.

Most people find Companies easy to understand as they are familiar with the concept of shares, which give one vote per share to the shareholder and the right to an equal share of any dividend that may be declared, but there is also great flexibility to a company share structure, allowing for the creation of non-voting shares, or shares with enhanced voting rights, shares that have a preferential right to a dividend (before the ordinary shares) or preferential rights on a winding-up, or no right to a dividend at all or a right only to such dividend as the directors decide (which can be used as a means to provide for an effective “bonus” for employee shareholders) or deferred shares whose rights only come to life when a certain event happens (e.g. an imminent sale of the Company). The Company is therefore a very adaptable creature.

In terms of taxation, the shareholders of a Company are only taxed on the amounts they receive from the Company (and at time of writing there is a tax advantage to receiving dividend income over salary for employee shareholders) and on any capital gain they realise on an eventual sale of the shares.

As with a GBP or LLP, it is a very good idea to set out an agreement between the shareholders at the outset as to how the Company is run. This should cover matters such as:

  1. who can appoint a director;

  2. how many directors there should be;

  3. how many directors must be present for a Board Meeting to be quorate (i.e. valid and able to make decisions);

  4. how shares can be transferred:

    1. freely transferrable?;

    2. offered to other shareholders first?;

    3. freely transferrable to family members only?;

    4. compulsory transfers on death/dismissal as an employee/retirement/breach of the shareholders agreement?;

    5. compulsory transfer to a 3rd party buyer if the other shareholders wish to sell to that buyer?

  5. any veto rights to protect the rights of minority shareholders who would otherwise be outvoted;

  6. how the company is to be financed, etc.

Again as for the GBP or LLP, if you don’t adopt a Shareholders Agreement then the legislation will do it for you, but in this instance it will take the form of the Articles of Association (which is an agreement that automatically binds all of the shareholders now or in the future) that are adopted when the Company is formed.

When you set up your company with a company formation agent (or your solicitor or accountant does it for you) then it will be set up with a form of Articles called the “Model Articles” unless you specify otherwise. The Model Articles are fairly simple and will not provide the degree of control that is typically advisable for a Company run by business partners. You can change the Articles adopted by the Company at any point provided 75% of the voting shares are in favour, but once the Model Articles are in place you may have lost the negotiating leverage (or appetite) to get them changed for something more appropriate.

What Do You Want From This Venture?

Once you have settled on your business structure, you really need to think about what you want from it, which will require some deep conversations with your prospective business partner. Some of the issues are foreshadowed in the discussion of the Company structure above, but they generally boil down to:

  1. What are your ambitions for the business?

    1. family business to pass down the generations?

    2. lifestyle business?

    3. build fast and sell fast?

    4. World domination/crush my enemies etc.

  2. How will you finance it?:

    1. bank finance/factoring etc;

    2. dip in own pockets?

    3. bring in new equity investors/partners?

    4. venture capital?

  3. Who will run it/Who will do what?

  4. How and when can you exit the business?

  5. Will you bring anyone else in (new investors/share options for incentivising employees)?

  6. What will happen if you fall out – sell/buy-out the other shareholder(s)or partners/wind up the business?

Measure Twice, Cut Once

Is the carpenters’ old adage, or “look before you leap” is also apposite. That would be the best advice before embarking on a business partnership. Blundering into a General Business Partnership with a mate may work fine for a while, but the most successful partnerships arise where the partners have a clear idea (and the same idea) of what they want to achieve and, most importantly, they commit that idea to writing in the form of an agreement.

For advice on business structures, entering into a partnership, or partnership or shareholder agreements, please contact our Corporate Partner, Iwan Emanuel on 01494 893 570