People often go into business together with a view to being equal in the business: to contribute equally and to be paid equally from it. Sometimes they put equal sums into the business to start it up and run it but at other times, one partner provides some expertise whereas another provides the finances.
Often, when first starting, not a lot of thought goes in to the structure of the business: whether it should be a limited company or a partnership. Most form limited companies and divide the shares equally between them. This is often because of an accountant’s advice (there are some tax advantages to running a limited company depending on your particular circumstances) and you are generally protected from creditors coming after your personal assets if it all goes wrong unlike in a partnership when your personal assets are up for grab. However, whatever the structure, the business owners think of themselves as equal partners.
Now fast-forward a couple of years. Things have soured between the owners. Maybe one thinks the other is contributing less, maybe the business itself wasn’t as sound as they first thought and there are some financial strains, maybe there is just a clash of personalities. One now wants to take over the business and go it alone. How is it different if the business is a partnership compared to if it is a limited company?
A partnership is a fairly loose business structure. It automatically comes into existence when two or more people go into business together with the view to making a profit. There does not have to be a written partnership agreement although it will almost always be preferable to have one. If there is no partnership agreement, or the agreement does not cover certain items, then the Partnership Act 1890 steps in to fill the gap. Profits and losses are shared between the partners, usually 50:50 in the type of scenario set out in this blog.
A limited company is a separate legal ‘person’ and must be formally set up and registered at Companies House. If will have members (shareholders usually) and directors. It is governed by its Constitution documents, which will be its Articles of Association, any shareholders’ agreement and certain shareholders’ resolutions. Profits are retained by the company itself but the directors and shareholders can agree to distribute some or all of the profit as dividends, in which case they will usually be distributed in proportion to the number of shares that each member holds.
In both situations, the owners can also be employees and earn a salary from the business.
The best time to think about what would happen if a partner or shareholder were to leave is when the partnership or company is first set up, although it can be addressed at any time. Any agreement would be put into a Partnership Agreement, or Articles or Shareholders’ Agreement.
But what happens if there is no written agreement?
In a partnership, if one partner wants to leave, then the partnership itself is dissolved. This usually means that it stops trading, assets are collected in, debts paid and any profit left over is shared between the partners. By agreement however, one partner can carry on the business and agree to pay out the leaving partner.
In a company, things are very different. A director can resign as a director of the company but this does not affect his shareholding. The leaving director will still own 50% of the company and be entitled to his share of dividends, even if he plays no further role in the company. He will still be entitled to copies of the accounts and other information and to be involved in any shareholders’ meeting. An agreement can be reached between the parties for the leaving shareholder to sell his shares but there are often difficulties in agreeing a price. Particularly, if the company is doing well, the remaining shareholder will have a strong incentive to buy out the leaving shareholder.
So what should be done?
1. Decisions about what structure to use generally come down to tax considerations and how important it is to you to protect your personal assets. It is best to speak to your accountant about this.
2. For both a partnership and a company, it is advisable to have formal documents (a Partnership Agreement or Shareholders’ Agreement) drafted at the outset. These will cover what happens if one of the owners leaves as well as many other matters such as what happens of the owners can’t agree on something. Such a document should be drafted by a solicitor who will discuss with you various problems that might arise in the future that you may never have considered and how they should be dealt with.
3. If you have never had a Partnership Agreement or Shareholders’ Agreement drafted, then it can be done at any time. The most important thing however is to do it before any problems arise between the owners.
4. If things are beginning to sour between the owners of the business, you should take legal advice as soon as possible to ascertain the strengths and weaknesses of you position and, using this information, develop a strategy for the negotiations so that you can achieve the best outcome for yourself.