6 Reasons You Need a Partnership Agreement for Your Small, Rural Business

Disclaimer: The content of this blog article is general advice. Those in partnerships looking to arrange a Partnership Agreement should seek specific advice for their own circumstances. 

If you’re in a business partnership (i.e. there are two or more of you, and the purpose of your business is to make a profit) it’s strongly advised that you draw up a Partnership Agreement

In the North East of Scotland, many small businesses run as partnerships. This includes businesses in retail and trades. Most often, agricultural businesses (family farms) are run as partnerships. 

But despite how much you feel you can trust your business partner (especially if they are your spouse or parent), you can’t rely on a ‘gentleman’s agreement’ or family relationships to see you through challenges in your business. 

Elaine at McKilligan Financial sets out the 6 main reasons she advises her small, rural business clients to get a Partnership Agreement in place

  1. A Partnership Agreement confirms the profit share that each partner is entitled to

Despite its name, being in a partnership does not mean that the profits of the business need to be split evenly between the partners. If you decide, and it’s set out in your Agreement (which should be reviewed and updated regularly), partners could have say a 70 / 30 profit share. This might suit businesses where one partner will be more involved in generating income and as such you agree to that partner having a greater profit share. 

  1. A Partnership Agreement may allow the allocation of salaries to partners

The same can be said for allocated salaries to partners. This provides flexibility to suit the varying circumstances of the business and its’ partners, and it can be useful from a tax planning perspective.

  1. A formal Partnership Agreement confirms the capital share that each partner has 

This doesn’t have to be the same as profit share. 

Where there is doubt (for example where the land is not in the partnership name) further steps should be taken to clarify the position. This might involve putting in place an appropriate declaration of trust (via a solicitor), or including a specific provision (for example in the Partnership Agreement) that the land is, or is not, partnership property.  

If you are in a farming partnership, and given the value of farmland, taking these simple steps improves clarity for the future. 

  1. It should also set out what happens when a partner retires, dies, or resigns from the partnership 

A well thought out Partnership Agreement will include clauses addressing the process to be followed to remove a partner from the partnership (whether through death, retirement or resignation). It should also, amongst other things:

  • set out how the business should be valued when a partner leaves (e.g. market value).
  • cover what should be included, and what shouldn’t, in the valuation.
  • make clear how the capital account should be paid out. 
  • set out the capital account payment term (e.g. in one lump sum or in instalments to help the cashflow of the business).

Without a formal Partnership Agreement, a business operates under the rules of the Partnership Act 1890. In this case, when it comes to the death of a  partner, the partnership is dissolved and ceases to exist. This can mean banking facilities are frozen and a business can find it difficult to operate in the immediate aftermath. 

If you have an Agreement in place, the remaining partner(s) should be in a better position to address some of these issues. For example, upon the death of a partner, you could state that the remaining partners will have the option to take on the assets and liabilities and therefore continue in business. 

Case Study
A well-known case, Ham v Ham (2013), highlights how important it is for Partnership Agreements to be clear about how partnership shares are to be valued when a partner leaves for any reason, including the death of a partner.

In this case, a son wanted to leave the farming partnership he had entered into several years earlier with his parents.

Their partnership agreement said that the remaining partners would buy out the leaving partner.

The son felt he should be paid out according to the full market value of the farm but his parents said his share should be based on the (much lower) book value of the assets.

The parents won at the initial hearing but the son won on appeal, entitling him to claim the market value on his share of the assets.
Because the agreement was not clear on how the share should be valued, the family went through a stressful, expensive and lengthy court case.

  1. A Partnership Agreement states what happens in the event of a dispute between partners

If you’re in disagreement about something in the partnership, and especially if you are family members, the dispute can get even uglier than choice words or silence around the workplace or dinner table. 

A Partnership Agreement can help reduce the likelihood of disputes by ensuring that each partner has an understanding of ownership, assets and profit sharing. 

It may seem unnecessary to have a formal written agreement in place between husband and wife for example but if a dispute does occur the Agreement will include a plan for how to move forward.

  1. Finally, a Partnership Agreement sets out responsibilities for the partners, such as working together in the best interests of the business

This can include things like:

  • how to deal with decision making and a voting deadlock.
  • how new partners can be brought in.
  • setting out business spending limits.

Think of a Partnership Agreement as an insurance policy: you hope you won’t need to refer to it often but it could save a lot of headaches (and heartaches)

Having a Partnership Agreement with appropriate clauses in it can help to manage your tax position, as well as look after your business. And if you wait until things go wrong, it’s too late. 

And if you don’t arrange one?

Your partnership without a Partnership Agreement in place will be subject to the provisions set out in the Partnership Act 1890 (legislation.gov.uk). These do not always offer the best business (and business relationship) solutions for your partnership. 

Equally it’s important your agreement covers every eventuality. If any areas are not covered in your Partnership Agreement, the rules of the Partnership Act 1890 come in to force. 

It’s a vital document for your small business, so you want to get it right.

Your next steps: speak to a solicitor 

A Partnership Agreement should be prepared in collaboration with your solicitor. The team at McKilligan Financial are happy to review it from a tax perspective. 

The McKilligan Financial team supports a broad range of rural businesses. 

Trusted  by clients in farming, the motor trade, construction, equipment hire, forestry and property rental, as well as individual tradespeople and other small businesses, McKilligan Financial is North East Scotland’s rural family business accountant.