People starting a business together often just get on with it.
They are so focused on what they are doing, the ‘business’ seems incidental – like when musicians start a band, or a husband and wife start to sell party poppers from their back bedroom.
If they just get on with it, they will be a partnership from day one. This happens by operation of law, there are no formalities.
Working with partners throws up many issues. When you work on your own, you are aware of the liabilities you take on but once there are a few of you, it is more difficult to keep tabs on those liabilities. Ok if you don’t expect significant liabilities, but risky if you do. Partnerships expose partners to joint unlimited liability for the business’s debts and obligations. That means you can be personally liable for that debt if the business goes bust.
So, you would want some agreement to keep partners in order. Although partnership law is well understood and the legislation is over 130 years old, it contains provisions which may not reflect the reality of the relationship. One is that all partners have equal status unless they agree otherwise. Obviously, this may not be intended when it comes to sharing out the profits or putting in capital. For these and many more reasons it is essential to have a partnership agreement and not just rely on the law for protection (of which there is very little).
People concerned about personal liability generally choose a company – a separate entity from the people who set up the business (who become its shareholders). It offers limited liability, is taxed separately and is subject to significantly more regulation. It is a relatively safe way to run a business from the point of view of protecting the rights of its shareholders and a shareholding offers rights that are capable of being transferred or inherited. Companies will always have a written constitution (articles of association), and it is advisable to have a shareholders agreement as well.
The third option is the LLP – limited liability partnership. This offers the tax transparency and financial flexibility of a partnership while offering the limited liability of a company. LLPs are more like companies than partnerships in that they are separate legal entities.
LLPs have been around for 25 years and are regularly used by professionals, fund managers and for joint ventures. They can be a good way of holding and structuring a property development. There’s a catch with LLPs. You really do need an agreement regulating the conduct and rights of the partners (known as ‘members’). It is very unwise to fall back on the law. The relevant legislation, the Limited Liability Partnerships Act 2000 and the Limited Liability Partnerships Regulations 2001, is not substantial and quite vague particularly when it comes to the death of a member. The default provisions are best avoided.
The following is a true(ish) story.
Tom and Dick develop properties through an LLP set up by their accountants who say that as the business is simple and they are equal partners, there is no need to ‘waste money’ on a members’ agreement.
The pair love to compete, take risks and dare each other. They always have several deals in the air at the same time. The business is a success. But paperwork, well that’s just a bit boring.
One day Dick has an unfortunate encounter with a brick and dies. Nobody is prepared for this.
His widow, Harriet, a hardworking and sensible soul, is concerned about what this means for the business and her family’s future.
She goes to see a partnership lawyer at Winckworth Sherwood, who consults the legislation.
As a start Regulation 7 provides that ‘all members …..are entitled to share equally in the capital and profits’ of the LLP. That at least confirms Dick’s entitlement to 50% whilst still a member.
The last accounts show ‘Equity’ of £3,000,000. The equity is the value of the business belonging to the members – their shares – and Harriet naturally expects 50% of that now belongs to her. She needs this to look after the family now Dick’s gone.
But the position is serious. There is no members agreement, so they are forced to rely on the Regulations and the Act for guidance.
Section 4(3) of the Act strongly implies that Dick’s death has the effect of terminating his membership of the LLP (although there is some confusion on the point).
Harriet has no right to step into Dick’s shoes and be registered as a member in her own right. Nor does she have any right to receive any payment for the value of his ‘share’ in the LLP either from Tom or the LLP itself. This may mean that the value of all of the assets of the LLP will end up with Tom. Harriet is shocked – she could lose at least £1,500,000. A members’ agreement between Tom and Dick would normally have specified what happens on the death of one of them – at the very least the right for the deceased’s estate to receive a repayment of the capital put in.
Harriet must find out if Tom agreed that she can become a member in Dick’s place or be entitled to a payment for his share in the LLP if he died, even if just a conversation. Of course, they have never even talked about it. If asked, would he be able to agree to this now? Would this give him a tax problem?
Meanwhile, Tom has also just got back from his lawyers. They have told him he may now own the whole business and warned him that if he continues to run the LLP with only one member after 6 months, he will also be liable for the debts of the LLP. He is going to need a new partner.
So, it’s clear that Dick’s’ death has left both Harriet and Tom in a bit of a pickle. And if Tom keeps Dick’s share, the tax could get messy.
Fortunately, as if by magic, Dick suddenly reappears with a large bump on his head and looking rather groggy, ‘Well Tom’ he says, ‘that’s the last time you dare me to try juggling’.
‘You bet’ interjects Harriet, somewhat relieved to see him alive, ‘and in the morning you and Tom are going straight over to Winckworth Sherwood to sort out a members’ agreement – you’re not in a circus’
‘A what?’ cry Tom and Dick.
‘You heard!’ says Harriet.
It’s never too late to put the right agreement in place for your partnership, company or LLP. Don’t leave a problem for your family that can easily be avoided.