Partnership agreements – planning for profits and losses

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The various options for sharing your profits and losses in a partnership

When setting up a business as a partnership, or revisiting your partnership agreement for any reason, it is important to consider the core topic of how profits and losses will be shared. Your partnership agreement needs to accurately reflect your true intentions as regards these matters, and it must provide sufficient detail to resolve any disagreements that may arise at the time of profit distribution.

If your partnership agreement is out of date, or poorly worded, and does not provide sufficient clarity about the distribution of profits and losses, then there is a risk that the Partnership Act 1890 will apply instead. This would not be in your interests, as it would apply a crude and rudimentary approach to sharing profits and losses, in that they are simply apportioned equally between the partners, which may be far from your intentions.

Common models for sharing profits and losses

There are a variety of models which you can choose between, or you can come up with an entirely novel and bespoke approach of your own, depending on your objectives. Some of the more common options include:

Equal sharing

The most simplistic of all the models, and one that mirrors the basic provisions of the Partnership Act 1890, is ‘equal sharing’. This simply means that all profits and losses are shared equally amongst the partners, irrespective of any other circumstances. The simplicity of this approach may appeal to you, and it can be an efficient model for a smaller business or a family business, where members think such an approach helps support and foster a culture of trust, cooperation, and fairness.

Similarly, equal sharing can be an effective model if you have broadly equal capital commitments and levels of responsibility across the partners. It is straightforward to calculate at the time of financial year end.

The main downside of equal sharing is that it is a rigid and inflexible model. Furthermore, this style of approach can create resentment between partners if one or more are not deemed to be ‘pulling their weight’ or hitting their targets.

Proportionate sharing

This model is where each partner’s share of profits and losses simply mirrors their capital contributions to the partnership. It is in many respects a fair and equitable model, as the distribution reflects the degree of financial risk assumed by each partner.

However, it is a relatively blunt instrument in that it fails to take into account any other factors, such as an individual partner’s role in the business, expertise or seniority.

Pot A and Pot B sharing

In this distribution structure, you have two different ‘pots’ at the end of each financial year, Pot A and Pot B. You can state the proportionate sizes of each pot in your partnership agreement – the two pots could be equal or different sizes. The idea is that all the partnership profits are paid into those pots in the proportions agreed. Pot A is then shared, usually equally, amongst all the partners. Pot B is shared, again usually equally, only among those partners who have hit their target for that financial year.

As you will expect, the intent behind this structure is to strongly encourage partners to hit their own financial targets, whether that be in billing (e.g. in professional services firms) or in sales. The difference between hitting target, or failing to do so, could lead to a significant impact on an individual partner’s annual remuneration. As such, this strategy tends to work best for growth-focussed firms, and those firms for which individual partner efforts (as opposed to wider team efforts) are fundamental to overall business revenues.

How we can help

Our solicitors will be able to advise you on all these options, and others, and will be able to take your plans and turn them into legally binding clauses for insertion in your partnership agreement.

If you are looking for advice regarding profits and losses distribution among your partners or require legal support with regards to your partnership business more generally, then our lawyers will be pleased to help.

For an informal conversation, please contact Olivia Chalmers in the corporate and commercial team on 01733 882800 or email [email protected]

Olivia Chalmers LLB, Partner

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