Forming a partnership

A partnership is a legal entity formed when two or more people — or companies — carry on a business together, intending to make a profit. It doesn’t matter if they make a profit. The law can find that a partnership exists even if it doesn’t make a profit.

Advantages

Partners can get personal tax exemptions and use partnership expenses as personal tax deductions during the startup phase of a new business. Shareholders in a company can’t do these things. Later, when the business grows and has greater risks, it may be good to convert the partnership to a company.

Disadvantages

Being in a partnership can have serious legal consequences. Most important is the potential joint liability — each partner could be personally liable for the acts or omissions of the other partners. Creditors of the partnership, or other people harmed by it, can sue one, some or all of the partners for their losses. So one partner could be responsible for all the losses of a partnership, even though they didn’t directly cause the losses.

But partners can take steps to reduce the risks. For example, they can use a limited liability partnership (LLP), explained below. And they can get insurance.

The Partnership Act establishes three types of partnerships:

• general partnerships

• limited partnerships

• limited liability partnerships

General partners share equally in the profits...

To understand how a general partnership operates, say you and your friend Lin want to open a store and be business partners. You would both be equal (50/50) partners. The law presumes that, as partners, you and Lin would share equally in the profits and losses of the partnership, unless your partnership agreement sets out a different split. And you would both have the right to manage the partnership.

...and share equally in the losses

General partners are each personally responsible for the partnership’s debts. This is true for both active and inactive partners in the business.

To show how a general partnership works, suppose that you and Lin borrow $10,000 to set up a shop. Your business doesn’t do well, and the partnership cannot repay the loan. The bank can ask you and Lin to pay back $5,000 each. But if Lin can’t or won’t pay their share, the bank can sue you alone for the whole $10,000. It would then be up to you to try to get Lin’s share from them.

And if you don’t have enough to repay the debt, the bank could take your personal assets — such as your house or car — even though they are not used in the business.

In contrast, company shareholders are liable for company debts only if they have personally guaranteed the company’s debts.

In a general partnership, each partner is personally liable for all the obligations of the partnership, including those resulting from any negligent conduct of a partner in the partnership business.

Each general partner is an agent for both the partnership and the other partners. You and Lin can both make contracts for the partnership that legally bind all the partners. If Lin signs a contract with Jane Jones for supplies for the partnership business, you, Lin, and the partnership must each fulfill the contract, whether you agree with it or not.

And any partnership agreement between you and Lin cannot limit your responsibility to people who innocently sign a deal with Lin, believing Lin is authorized to act for the partnership.

General partners owe a duty to each other to act with good faith and fairness. You must 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 kickbacks from suppliers.

Limited partnerships are mainly for investors who want to invest in a partnership business, but who don’t want to run the business. If you’re an investor only, you could be a limited partner and you would be responsible only for the debts of the partnership up to the amount of money you invested or agreed to invest. This is true if you don’t help manage the partnership. But if you help manage the business, then you would have the same liability as if you were a partner in a general partnership.

A limited partnership must have at least one general partner who has the usual unlimited personal liability described earlier. Usually, the general partner is a company incorporated just for that purpose, so that its shareholders aren’t personally liable for the obligations of the company (see our information on companies). The general partner is the only partner who can manage the business, so the shareholders who have most of the voting shares of a general partner company also control the management of the partnership business.

A limited liability partnership (LLP) is an alternative to a general partnership. If you’re a partner in an LLP, you aren’t liable for the obligations of other partners or the partnership that you would be liable for in a general partnership — unless those obligations result from your own actions or inaction. If you haven’t personally incurred any debts, the most you would lose is your investment in the partnership. Your personal and other assets, like your home, wouldn’t be at risk. So with a limited liability partnership, you can help run the partnership business, but have some protection from being sued for the negligence or wrongdoing of your partners.

It’s possible to convert a general partnership or limited partnership to a limited liability partnership.

A partnership doesn’t have to pay any income tax on its profits. But each partner must pay income tax on their share of partnership profits.

If a partnership loses money, the losses are divided among the partners in the same way as profits would be. For income tax purposes, it’s as though each partner had lost that money running their own business.

Before setting up a partnership, consider getting income tax advice from a qualified professional.

Any partner can end a partnership any time by giving notice to all the other partners — unless the partnership agreement says otherwise. Alternatively, a partnership agreement can set a fixed term for the partnership, meaning it automatically ends after a certain time, or after a task or project ends.

When the partnership is over, you file a dissolution of partnership registration with the BC Registrar of Companies. At that point, your ongoing liabilities end.

Disputes between partners

Under the Partnership Act, a partner cannot be expelled from a partnership, even by a majority vote, unless the power to do so is in a partnership agreement. If no expulsion power is in the partnership agreement, the only option would be to dissolve the partnership.

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

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

• Will you share the profits 50/50? What if one of you puts up more money at the start than the other?

• Will you share equally in the losses?

• Who will manage the business? (If you’re going to run the store and expect to get a salary, this should be included in your agreement or in a separate employment agreement.)

• How much money or property (for example, equipment) 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 must?

• 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 their obligations?

Verbal partnership agreements or hand-shake agreements are enforceable, but they can pose problems. Partnership agreements should be in writing, dated, and signed by all parties, so you can more easily prove its terms and have more certainty in your business. The best time to create a partnership agreement is early, before disagreements arise and become unsolvable.

Limited partnerships and limited liability partnerships must be registered with the Registrar of Companies. The Partnership Act has a list of the documents that must be filed to create these partnerships. General partnerships should be registered, but they still exist even if you don’t register them.

You should 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 must 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 using your partnership name. Depending on the type of partnership, there are procedures for using 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 must also file other information and documents with the provincial government.

Small Business BC is a government resource centre with information and free guides. Call 604-775-5525 in Vancouver or 1-800-667-2272 elsewhere in BC.

See the Ministry of Finance small business website.

Also see the provincial government’s Resource Centre for Small Business.