The importance of partnership agreements for family businesses

For many family businesses, arrangements have developed over a number of years, with each member understanding their respective roles and trusting each other completely. That can make a formal partnership agreement seem an unnecessary investment.

But relying on an informal understanding can create difficulties when circumstances change. A written agreement gives the family business a clear framework for dealing with decisions, assets, profits and, importantly, the unexpected.

The law states that two or more people carrying on a business together with the intention of making a profit automatically creates a partnership. So, in the event of at least two people running a business, the default structure is a partnership. Without an agreement, the Partnership Act 1890 provides the default rules. Because this act has been around for some time, the rules within it may not be suitable for a modern family business. For example, under the Act, a partnership automatically dissolves on the death of one of the partners, meaning that bank accounts could be frozen and banking facilities and charges renegotiated causing practical problems at an already stressful time.

It also gives each partner full power to bind the partnership in contract, allowing that new partner to spend on the shiny new car or diversify without the agreement of the other partners.

A well-drafted agreement can instead set out what happens if a partner retires, dies or wants to leave, including how their share is valued and paid. It can also establish how new partners are admitted, how decisions are made and what happens if the partners cannot agree.

Another important consideration is establishing exactly what belongs to the partnership. A business may use assets that are owned personally by one of the partners. If this is not clearly documented, disagreements can arise later about ownership and the treatment of those assets.

This can have significant tax implications. A detailed agreement can provide evidence of the structure and ownership of the business, which may be important when considering Business Property Relief and or Agricultural Property Relief for inheritance tax purposes.

A partnership agreement is about more than preparing for a dispute. It is an opportunity to have an open conversation about how the business operates today and how it should develop in the future.

It can also prompt partners to review their wills and wider succession plans, ensuring that their personal wishes are consistent with the arrangements for the business.

Family businesses may not expect circumstances to change dramatically. But retirement, death, illness, disagreements or the arrival of the next generation can all alter the position. Putting arrangements in writing while relationships are good can help protect both the business and the family when change does come.