Two people start a business together, shake hands, and agree to split it down the middle. Five years later one wants out, one has stopped turning up, and there is no document. What governs them is the Partnership Act 1890 — a statute older than the motor car, whose default rules almost certainly do not say what either of them assumed, and one of which is that the partnership can be dissolved by any partner giving notice.
What the default rules actually say
Where there is no agreement, the Act fills the gaps, and its defaults are rarely what partners want:
- Profits and losses are shared equally — regardless of how much capital each partner introduced, how many hours each works, or who brought in the clients;
- Every partner may take part in management, and ordinary decisions are taken by majority — but a change in the nature of the business needs unanimity;
- No partner is entitled to a salary for acting in the partnership business;
- New partners require unanimous consent, and no partner may be expelled by majority vote unless the partners have expressly agreed that power;
- The partnership dissolves on the death or bankruptcy of a partner, and a partnership of no fixed term can be dissolved by any partner simply giving notice.
That last default is the one that causes the damage. A partner in dispute can end the business by writing a letter, forcing a winding up in which assets are sold and the enterprise the others built stops existing. An agreement replaces that with a retirement mechanism.
Note too that partners are jointly liable for the debts of the firm — and liability is unlimited and personal. One partner's commitment binds the others, whatever the internal understanding was, which is why the authority to commit the firm is worth defining in writing before it is tested.
What a working agreement covers
The document does not need to be long; it needs to answer the questions that will actually arise:
- Capital and profit shares — how much each partner contributed, whether interest is paid on capital, how profits are divided, and how drawings work between profit allocations;
- Roles, hours and decision-making — who does what, which decisions need unanimity and which a majority, and what happens when there is deadlock in a two-partner firm;
- Admission, retirement and expulsion — notice periods, whether a retiring partner's share is bought out and on what valuation basis, and the grounds on which a partner can be required to leave;
- Death and incapacity — including whether the firm continues, and whether the estate is paid out over time rather than immediately, which is the difference between an orderly succession and a forced sale;
- Restrictive covenants — non-compete and non-solicitation terms that are narrow enough to be enforceable;
- Dispute resolution — mediation or expert determination before litigation, which is worth more than it costs on the day it is used.
The valuation clause deserves particular attention. Agreeing the method in advance — a multiple, an independent valuation, a formula based on capital accounts — removes the most contested question in any partnership exit, because it is settled while everyone still expects to be on the same side of it.
The tax dimension
A partnership is transparent for tax: it does not pay tax itself. It files a partnership return reporting the profits and their allocation, and each partner is taxed individually on their share — income tax and Class 4 National Insurance for individuals, corporation tax where a partner is a company.
Two consequences follow. First, partners are taxed on their profit share, not on what they drew — so a partner who left profits in the business still pays tax on them, and the agreement should require drawings to allow for that. Second, changes in profit-sharing ratios mid-year need documenting, because HMRC will tax the allocation the records support rather than the one everyone remembers agreeing.
Partnership or LLP?
For most new ventures the real choice is between a general partnership and a limited liability partnership. An LLP gives the members limited liability and separate legal personality while keeping the same tax transparency — the significant advantage. The costs are public: an LLP files accounts and a confirmation statement at Companies House, so its financial position is visible in a way a general partnership's is not.
A general partnership remains a reasonable choice where the activity carries little liability risk and privacy is valued. Where the work could generate a claim, or where the partners have personal assets worth protecting, the LLP is usually worth its disclosure cost. Either way the internal document matters just as much: an LLP without a members' agreement falls back on default regulations that are, if anything, less suited to a real business than the 1890 Act.
Acumon advises on partnership structure, profit-sharing arrangements and the tax that follows through business tax work, and prepares partnership and LLP accounts and returns. If your firm is operating on a handshake, the cheapest moment to write it down is while everyone still agrees what was said.