A business partnership allows individuals and companies to band together to operate in commercial activities. However, from a legal standpoint, a partnership is just one of several relationships and structures businesses can adopt to operate effectively. Whether launching a new venture or evaluating your existing business setup, understanding the nuances of partnerships and alternative options is crucial for achieving your goals.
When setting up a business, the three most common structures are sole proprietorships, partnerships, and limited companies. Each has unique advantages and limitations, which can significantly impact your tax obligations, liability exposure, and operational flexibility. While no two businesses are identical, and many adopt complex arrangements to suit their specific needs, the right choice requires careful consideration of the legalities and practicalities involved.
Key considerations when choosing a business structure
One of the primary factors influencing the choice of business structure is taxation. Generally, limited companies benefit from more favourable tax rates compared to individuals or partnerships. For instance, corporate tax rates are often lower than income tax rates, making incorporation a viable option for businesses generating substantial turnover or profit. Additionally, owners of limited companies are not personally liable for corporate tax, provided they operate the business responsibly and avoid insolvency.
In contrast, partnerships and sole traders are taxed personally on their share of the profits. While this may be manageable for smaller operations, as the business grows, the tax burden can become significant. For many entrepreneurs, transitioning to a limited company structure at the right stage of growth can lead to significant tax savings.
Another key consideration is the level of liability protection afforded by the chosen structure. A limited company is a separate legal entity, meaning it bears responsibility for its debts and obligations. This shields shareholders and directors from personal liability, except in cases where personal guarantees have been provided, or the company has been mismanaged.
This distinction can provide peace of mind, particularly in industries with higher risk profiles. For example, if a customer sustains an injury on your business premises, a limited company would bear the liability for any compensation claims, not the individual owners. However, lenders and creditors may sometimes require personal guarantees, particularly for loans, effectively extending liability to business owners.
However, in a partnership, liability is shared among the partners, with each personally responsible for the business’s debts and obligations (including any liabilities incurred by other partners). As a result, it is essential to carefully select your business partners and establish clear agreements to protect all parties involved.
Finally, operational flexibility is another important factor. Unlike sole proprietorships and partnerships, limited companies have a distinct legal identity. This allows them to own assets, enter into contracts, and operate independently of their owners. The latter can make the business more marketable, whether for future sale, expansion, or joint ventures with other companies.
Partnerships, on the other hand, are considered a halfway house between sole proprietorships and corporate entities. While partnerships can provide a collaborative framework for business operations, they lack the same level of independence or flexibility as limited companies. Instead, partners remain personally liable for the partnership’s obligations and are typically taxed on their individual income.
The importance of a partnership agreement
If you opt for a partnership, the arrangement must be formalised with a well-drafted partnership agreement. Under Scottish law, partnerships can exist as “partnerships at will,” which are essentially verbal agreements. Although this might work in the early stages, relying on verbal arrangements leaves partners vulnerable to disputes and misunderstandings.
A written partnership agreement ensures clarity on critical matters such as profit-sharing,
decision-making, dispute resolution, and the process for dissolving the partnership if necessary.
Without a formal agreement, conflicts can escalate, particularly during challenging times. A partnership agreement provides a clear roadmap, minimising risks and creating trust among all individuals involved.
Commercial status and professional guidance
Selecting the right business structure is one of the most significant decisions for any entrepreneur. Your choice of sole proprietorship, partnership, or limited company will shape your tax obligations, liability exposure – and growth potential. As your business evolves, it is equally important to review your structure, so it remains aligned with your goals and market conditions.
Professional advice is invaluable in navigating these decisions. Legal and financial experts can help you evaluate your options by assessing factors like industry-specific regulations, operational needs, and long-term objectives. Making informed choices and periodically reassessing your structure can help optimise your business’s performance and resilience.
Assess your options
Business partnerships offer a collaborative and potentially rewarding approach to entrepreneurship. However, they also come with specific risks and limitations, particularly concerning taxation and liability. For many Scottish businesses, a partnership represents a practical starting point, yet transitioning to a limited company may become a strategic necessity as the business grows.
Whatever your approach you choose, a proactive approach to legal and financial planning is essential. With the right guidance and a clear understanding of your needs, you can establish a foundation supporting your immediate goals and future ambitions. So, whether you’re forming a partnership, launching a sole proprietorship, or incorporating a limited company, taking the time to make informed decisions will pay dividends in the long run.
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John Roberts is a Partner and Director at Austin Lafferty Solicitors. John has been with the firm for almost 20 years, with experience in all areas of business law.