Planning to go into business with a friend or colleague? Partnerships are a popular business structure in Australia, and there are plenty of reasons why they’re a fantastic way to get your business off the ground.
However, partnerships also come with their own set of drawbacks and risks – and they generally don’t stay cost-effective forever. To help you decide whether a partnership is the right business structure for you, I’ve broken down some of the biggest pros and cons of partnerships below.
Just quickly – what exactly is a partnership?
A partnership is a business entity formed by two or more people. It operates in a similar way to a sole trader business structure, in that it’s largely unregulated by ASIC and you’ll be taxed as individuals. How partnerships are operated internally is up to the partners themselves.
There are three types of partnership structures in Australia:
- General Partnerships are the most common. Management responsibilities, liability, and profits are divided among all partners as per their established agreement.
- In a Limited Partnership, each partner’s input and liability is based on the percentage of their investment in the business. It’s best suited to short-term agreements.
- A Joint Venture is essentially a short-term general partnership, with an agreed start and end date.
Low compliance costs mean that partnerships are great for getting started.
One of the biggest advantages of a partnership structure is that they’re cheap to set up. If you’re starting at square one and you don’t have a lot of capital to spare, this makes a partnership ideal.
Other business structures – like companies or unit trusts – are much more complex and heavily regulated than partnerships. When you’re setting up a trust or a company from scratch, compliance costs can quickly become very expensive.
Conversely, partnerships follow a very simple registration process, and your ongoing financial & reporting obligations are fairly minimal. All you really need to get started is a form of agreement between all parties.
Although partnerships between individuals are generally very simple, there’s room for them to get a bit more complex. Partnerships can also be formed between two companies or other business entities, and a joint venture partnership of this nature can be a great way to own property developments. In this situation, each company or entity is still taxed in it’s own right.
A straightforward tax situation makes it easy to distribute profits and losses.
Just like a sole trader, a partnership is not a separate legal entity. Whilst partnerships must file annual tax returns, they do not pay income tax as a business.
Instead, each partner pays tax on their share of the net income of the partnership. This means that you must file both an individual and a partnership tax return. It also creates an advantageous situation if the business makes a loss.
When a company makes a loss, it carries over to the following year. However, losses in a partnership are distributed annually amongst the partners, just like the profits. This means that partners can deduct losses from the business partnership on their individual tax returns.
Partnerships are risky because you’re personally liable.
The flipside of partnerships not being a separate legal entity is that the personal assets of the partners are not well protected. In business structures like a company or a trust, there’s a distinction between what belongs to the business and what belongs to the individual.
A partnership has no such safeguards – and it’s why you should never, ever hold your personal property in your name if you’re part of a partnership. If the partnership’s assets are insufficient to settle an issue, your personal assets will be next in line for the banks or other creditors.
Whilst this is also true of a sole trader structure, there’s an extra level of risk in a partnership. Partners can be sued personally for anything done in the name of a partnership, meaning you could find yourself exposed by the actions of your business partner.
And if another partner cannot or will not pay their share of the liability, you could be left with the bill. This feeds into the other major disadvantage of this business structure – potential conflict.
Minimal regulation means lots of grey areas. This can lead to conflict between partners.
The ‘jilted business partner’ is such a popular trope in TV and film that most people are keenly aware of this potential pitfall. It may give you pause before diving into a partnership, given that it’s such a flexible business structure.
However, after over 20 years as a business advisor, I can confidently say that full-on relationship breakdowns between partnerships are actually pretty rare. Most people just won’t get into partnerships with someone they don’t trust or can’t work with. But that doesn’t mean conflict doesn’t happen.
This is why it’s so important to outline a clear and comprehensive written agreement at the beginning of a partnership. You should get in touch with your lawyer if you’ve got one. Although it’s not an official requirement, having something binding will go a long way towards resolving potential conflicts before they happen. Make sure everybody involved has a clear understanding of how your business will work.
Partnerships shouldn’t be forever. You need to know when it’s time to roll over into a new business structure.
While a partnership is a great, cost-effective way to get your business off the ground, it’s definitely not ideal as a long-term structure.
Once your business starts to grow and accumulate some serious profits, a partnership will usually cease to be a cost-effective or tax-effective structure. A trust or a Propriety Limited company is generally a much more secure and efficient option when you’re dealing with a rapidly growing business & a lot of capital.
You may not have had the funds to set your business up this way initially, but it’s a good idea to roll over once you’ve got some strong momentum going. Transferring out a partnership and into a company also offers significant tax relief, particularly around capital gains.
It’s not always obvious when you’ve reached this tipping point, so we recommend partnerships meet with a business advisor once a year to analyse whether now is the time to roll over to a new business structure. An advisor will also be able to help you identify which new structure – a trust or a company – will better suit your business.
When it comes to business structures, our advisors are the experts.
Whether you’re about to embark on a partnership and are seeking guidance, or you need advice on rolling over into a new business structure, we’ll make the whole process simple. Get in touch today for a free and confidential chat.
The information in this article is of a general nature. It does not take your specific needs or circumstances into consideration. You should look at your own financial position, objectives and requirements and seek financial advice before making any financial decisions.
