This is the origin story of many businesses: you and your friend have known each other for years. You have common interests and are passionate about the same things. Over dinner one night, you agree to start a business together and shake on it. Done deal.
Three years into the partnership, an argument starts over who owns what duties and who deserves what compensation. Lawyers get involved. You probably know how this ends.
While business partnerships are frequently created through verbal agreements, this is not best practice. Relationships change, goals and objectives evolve, and reality might fall short of expectations.
Written and signed agreements are necessary to protect all parties involved.
As with any relationship, a business partnership requires clear communication about what is expected and by establishing rights and duties on paper before entering the partnership, there are fewer chances of a dispute later on.
What is a business partnership?
In a previous blog post, we spoke about the tax regulations for each business structure, including those with partnerships. A business partnership is “is a non-incorporated business that is created between two or more people,” according to the Canadian government.
Three types of partnerships exist in Canada:
- A General Partnership: each partner is personally liable for the debts of the partnership.
- A Limited Partnership: a single general partner operates with unlimited liability and gets the biggest share of earnings. They contribute the most and assume more risks. Limited partners contribute to the business, but are not involved in management and their liability is capped.
- Limited Liability Partnership: this partnership is formed by two or more partners with equal rights and powers, but partners in an LLP are not personally liable for any debts, obligations, or liabilities of the business. In most provinces in Canada, except for British Columbia, LLPs can only be formed by professionals like lawyers, accountants, and doctors.
What is a partnership agreement and why should it be in writing?
On purely legal terms, you can enter a partnership with just a handshake. That verbal agreement is a legally binding contract “as long as they are reasonable, equitable, conscionable and made in good faith.” That being said, it is very difficult to prove such agreements, as there is no physical proof and, since we are all human, memories fade and things can be miscommunicated.
A partnership agreement is a contract for two or more individuals to form a business partnership, which lays out the terms and conditions of the relationship. This can include:
- Percentage of ownership
- Division of profit and loss
- Length of partnership
- Description of the duties and powers of each partner
- Withdrawal terms
There aren’t any laws preventing you to work with a business partner without agreement documents, but protecting income and property should always be a top priority. The following are some reasons why you should seriously consider a written agreement prior to entering a business partnership:
- Outline roles and responsibilities: There can be a lot of ambiguity in terms of who does what in a partnership – who will manage day-to-day operations? Who will oversee finances? It’s important to answer these questions before forming a partnership, as it will simply affect the business if partners dispute over responsibilities.
- Establish income: Yes, you want to start a business because you are passionate about the service/product you are selling, but you also want to make a profit. Money can be a touchy subject, but the income of each partner needs to be established from the beginning. You should also determine how much of the profits will be invested back into the business.
- Avoid tax complications: As with any business type or structure, it’s important that your business is compliant with tax regulations. By having this written out in a contract, you’ll avoid any mistakes and subsequent issues (hello, CRA!) that may come with it. If you have any questions about your business’ taxes, our team of tax specialists, accountants, and bookkeepers can answer them!
- Avoid liability issues: in a general or limited partnership, you’ll need to clarify the liability of each partner. Who will act as managing partner? Who is the general partner vs. a limited partner? Depending on the structure of your organization, how much each partner initially invested, and how much is contributed day-to-day, each partner may have different liabilities.
- Avoid personal conflicts: Some business owners feel that written agreements are not necessary if the shareholders are all family members or close friends, but in reality, a shareholders’ agreement is often most essential when this is the case. When relationships are fluid between personal and professional lines, emotions can get involved.
In a partnership, everyone has a stake in the venture and wants to see it succeed, however, as they say, the devil is in the details. It serves you and your business well to leave nothing ambiguous and, instead, outline expectations.
Take note that an agreement does not necessarily constitute an enforceable contract: you’ll need professional advice from accountants and experienced attorneys to craft a contract (a specific type of agreement) that is enforceable. Give us a call at 647-476-2145 or schedule an appointment and we can create a roadmap that makes sense for you and your partner(s), put you in touch with the right legal team, and, of course, ensure your business is tax compliant.