When considering buying a franchised business, a partnership might be the legal vessel through which you decide to do so. There are both positive and negative factors you must evaluate when deciding whether a partnership is a more appropriate business structure than, for example, a company, a family or unit trust or a sole trader.

Operating a franchised business through a partnership may offer the following advantages.

Simple and inexpensive

1. The primary concern and cost in setting up a partnership is the drafting and signing of a partnership agreement. Just as a franchise agreement is an essential document governing a franchisor/franchisee relationship, so too is a partnership agreement critical to regulating a partnership. In this regard, you also need to ascertain, before expending any money on establishing a partnership, that a partnership falls within one of the franchisor’s approved franchisee entity structures.

2. A partnership agreement ought to articulate, among other things, how profits and losses of the business will be shared, debts paid, capital contributions made, roles and decision-making responsibilities distributed, and disputes resolved. The agreement should also cover entry and exit (including wind-up) strategies to deal with a new partner wishing to enter the business, an existing partner retiring or dying or being expelled, or the business failing.

3. If there is no clear agreement between the partners, then the relevant State or Territory partnership legislation will determine the partners’ rights and obligations. Such legislation generally provides that partners are entitled to share equally in the capital and profits of the business.

4. Taking care to ensure, from the outset, that the terms of your partnership are agreed upon and carefully documented may prevent disputes escalating during the operation of the business.

5. For example, in 2015 the Supreme Court of New South Wales heard a claim between partners of a Gloria Jeans franchise business concerning their remuneration and share of the profits and losses of the business. The case turned on the proper interpretation of the partnership agreement which had been prepared by an accountant who had no legal training. It had been prepared by adapting an inappropriate precedent that was found on the internet. The Court found there were serious inadequacies in the drafting of the agreement which “perplexed” the Court and led to difficult, time consuming and costly legal arguments on its meaning.

6. Further start-up costs may include registering a business name for the partnership.  If the partnership intends to trade under a business name other than the names of the individual partners, which is likely if you are granted permission to trade under the name of a franchisor, the name must be registered with the Australian Securities and Investments Commission.

Variations

7. Once formalised, a partnership agreement is relatively easy to amend.  If the partners agree to alter their profit-sharing arrangements or other aspects of the business, this can be achieved via a variation to the partnership agreement (subject to any prior notice that a franchisor may require).

Ongoing costs

8. A partnership is likely to face fewer ongoing compliance and regulatory costs than a corporate entity.  For example, a partnership is not required to keep and maintain records with the Australian Securities and Investments Commission. However, accounting fees for the purposes of taxation compliance will of course need to be incurred.

Taxation treatment

9. The income, capital gains and losses of a partnership are taxed in the hands of the individual partners at their relevant personal tax rate according to their proportionate share of the partnership’s profits and losses. Partners may therefore beneficially apply losses from the partnership business against other income they have received. This may be a persuasive consideration if, for instance, there are substantial differences in income levels of the partners.

Despite these potential advantages of operating a partnership, there may be the following disadvantages.

Implied agency

1. Each partner is an agent for the business. Each partner therefore has authority to bind the partnership (and all other partners) to any act performed or contract made by that partner in the course of the business. This means that one partner may be liable for the conduct of a co-partner which was neither approved by nor disclosed to the first partner.

2. For example, in another New South Wales Supreme Court decision, it was decided that a wife, in a husband and wife partnership operating a franchise for the repair and restoration of vinyls, plastics and leather, was a party to the relevant franchise agreement despite not having signed it. Only the husband had signed the franchise agreement.  However, he did so “on behalf of the partnership” since the business was to be conducted by the partnership and he had implied actual authority to bind her to the agreement.

3. Having said that, partners also owe strict “fiduciary” duties to act in the interests of the partnership rather than their own self-interests.

Unlimited liability

4. Relatedly, each partner has unlimited liability for the debts and conduct of the business, including the actions or negligence of the other partners. Partners are jointly and individually liable for the debts of the business: if one partner defaults, the co-partner can be personally liable. A partnership structure therefore affords little personal protection.  Please note, however, that there may be an opportunity in your State or Territory to form a limited liability partnership.

Conflict

5. Despite conducting extreme due diligence on your prospective co-partners, including as to their financial situation and business experience, partnerships may nevertheless give rise to personal conflict and deadlocks. To try to avoid such issues arising, ensure that regular communication is mandated between partners and that each partner has a specific, non-overlapping role in the business.

If you decide that a partnership is the right business structure for your needs, you should speak to your lawyer and accountant to ensure smooth sailing for your business.