How to form a partnership?

Partnership is a unique business structure that allows two or more people to hold shared ownership of a single business. Each partner is responsible for contributing money, property, labor or skills. In return, each partner shares in the profits and the losses of the business.

Business partners often start businesses together with little planning and few ground rules. Sooner or later, they discover the hard way that what’s left unsaid or unplanned often leads to unmet expectations, anger and frustration. Partners can clash over countless things, including conflicting work ethics and financial goals, roles in the business and leadership styles. What follows is a primer on how to avoid that and set up and sustain a business partnership.

A Partnership is governed by the Indian Partnership Act, 1932 and is defined as 'the relation between persons who have agreed to share profits of the business carried on by all or any of them acting for all.

A firm is strictly not a person; It is an association of persons and the agreement by which a firm purports to enter into a partnership with an individual or another firm merely makes the partners of that firm individual partner of the larger partnership. A firm as such cannot enter into an agreement as a partner with another firm or individuals.

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Therefore, when one partnership enters into a partnership agreement with another partnership firm, the partnership is in fact between all the partners of both the firms.

Read Legal Benefits Of Forming A Limited Liability Partnership In India

This definition gives three minimum requirements to constitute a partnership, viz. 

  • There must be an agreement entered into by the persons who desire to form a partnership, 
  • The object of the agreement must be to share the profits of business intended to be carried on by the partnership, and 
  • The business must be carried on by all the partners or by any of them acting for all of them.

A General Partnership is a business structure in which two or more individuals manage and operate a business in accordance with the terms and objectives set out in the Partnership Deed. This structure is thought to have lost its relevance since the introduction of the Limited Liability Partnership (LLP) because its partners have unlimited liability, which means they are personally liable for the debts of the business. However, low costs, ease of setting up and minimal compliance requirements make it a sensible option for some, such as home businesses that are unlikely to take on any debt. Registration is optional for General Partnerships.

Procedure to Form A Partnership

Choose a partnership name- The partners are free to choose any name as they desire for their partnership firm subject to the following rules:

  • The names must not be too identical or similar to the name of another existing firm doing similar business, so as to avoid confusion. The reason for this rule being that the reputation or goodwill of a firm may be injured, if a new firm could adopt an allied name.
  • The name must not contain words like Crown, Emperor, Empress, Empire or words expressing or implying the sanction, approval or patronage of the Government, except when the State Government signifies its consent (in writing) to the use of such words as part of the firm name.

Create a partnership deed- The document in which the respective rights and obligations of the members of a partnership is written is called the Partnership Deed. A partnership deed agreement may be written or oral. However, practically an oral agreement does not have any value for tax purposes and therefore the partnership agreement should be written. The following are the essential characteristics of a partnership deed:

  • Name and address of the firm as well as all the partners
  • Nature of business to be carried on
  • Date of commencement of business
  • Duration of partnership (whether for a fixed period/project)
  • Capital contribution by each partner
  • Profit sharing ratio among the partners

The above are the minimum essentials which are required in all partnership deeds.

Consider whether additional clauses are needed. The partners may also mention any additional clauses. Some of the examples of additional clauses which may be mentioned in the partnership deed are mentioned below:

  1. Interest on the partner’s capital, partners’ loan, and interest, if any, to be charged on drawings.
  2. Salaries, commissions etc, if any, payable to partners
  3. Method of preparing accounts and arrangement for audit
  4. Division of task and responsibility, namely, the duties, powers and obligations of all the partners.
  5. The rules to be followed in case of retirement, death and admission of a partner

Conclude the partnership deed in the appropriate form- The deed so created by the partners should be on a stamp paper in accordance with the Indian Stamp Act. Each partner should have a copy of the partnership deed. A Copy of the Partnership Deed should also be filed with the Registrar of Firms in case the firm is being registered.

Decide whether or not to register the partnership firm- Partnerships in India are governed by the Indian Partnership Act, 1932. As per the Partnership Act, registration of partnership firms is optional and is entirely at the discretion of the partners. The Partners may or may not register their Partnership Agreement. However, in the case where the partnership deed is not registered, the partners may not be able to enjoy the benefits which a registered partnership firm enjoys.

  • Registration of a partnership firm may be done before starting the business or anytime during the continuance of partnership. However, where the firm intends to file a case in the court to enforce rights arising from the contract, the registration should be done before filing the case.

Registration-The procedure for registration of a partnership firm in India is fairly simple. An application and the prescribed fees are required to be submitted to the Registrar of Firms of the State in which the firm is situated. The following documents are also required to be submitted along with the application:

  • Application for Registration of Partnership in Form No. 1
  • Duly filled specimen of Affidavit
  • Certified True Copy of the Partnership Deed
  • Ownership proof of the principal place of business or rental/lease agreement thereof.

The registration process to proceed formally- When the registrar is satisfied with the points stated in the partnership deed, he or she shall record an entry of the statement in a register called the Register of Firms and issue a Certificate of Registration. The Register of Firms maintained at the office of the Registrar contains complete and up-to-date information about each registered firm.

  • This Register of Firms is open to inspection by any person on payment of the prescribed fees; any person interested in viewing the details of any firm can request the Registrar of Firms for the same and on payment of the prescribed fees, a copy
  • Registration for tax- It should be noted that registration with the Registrar of Firms is different from registration with the Income Taxation Department. It is mandatory for all firms to apply for registration with the Income Tax Department and have a PAN Card. After obtaining a PAN Card, the partnership firm is required to open a Current Account in the name of the partnership firm and to operate all its operations through this bank account.

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Addressing these issues or complying with the law up front will help you better focus on your business later. How you work out the details of setting up a partnership could be an indicator of how well or poorly your prospective venture will operate. Inevitably, some potential partners will realize through the process they weren’t meant to be.