Starting a Business With Friends — What Are the Hidden Risks?

The Appeal — and the Danger — of Going Into Business Together

Starting a business with friends can seem ideal: you share goals, trust each other, and believe you work well together. But friendship and business operate under very different rules. Without a formal legal structure and clear written agreements from the outset, misunderstandings about ownership, profit sharing, decision-making authority, and exit arrangements are almost inevitable. Many business relationships between friends collapse — not because of strategic disagreement, but because of fundamental misunderstandings that could easily have been addressed by a well-drafted agreement. The English legal system provides several tools to protect business founders, but they are only effective if used proactively.

Choosing the Right Business Structure

The most critical early decision is choosing the right business structure. Sole trader, traditional partnership, Limited Liability Partnership (LLP), and private limited company each have very different legal consequences. A traditional partnership under the Partnership Act 1890 arises automatically if two or more people carry on a business in common with a view of profit — even without any formal agreement. The 1890 Act presumes equal profit sharing and equal decision-making rights regardless of actual contributions. More critically, partners in a traditional partnership have joint and several liability for all partnership debts and for the acts of their fellow partners. This means each partner's personal assets — including their home — can be seized to meet partnership debts.

The Risks of Informal Arrangements

If there is no written partnership agreement, the default rules of the Partnership Act 1890 apply, and they often produce outcomes that surprise the parties. If one friend contributes capital and another contributes labour, but no agreement specifies how profits are to be split, the 1890 Act treats them as equal partners. If one partner wants to leave, there are limited default rules about valuing their share. If partners disagree about a fundamental business decision, there is no default mechanism for resolving the deadlock. These problems are compounded by the fact that partners are liable for each other's conduct — if one friend makes a negligent or dishonest business decision, the other friends can be held personally liable for the consequences.

Limited Companies and LLPs

To limit personal liability, most business founders choose either a private limited company or an LLP. Both structures limit the owners' liability to the amount they have invested. A limited company is incorporated at Companies House, has shareholders and directors (who may or may not be the same people), and is subject to the Companies Act 2006. An LLP is a hybrid that combines corporate liability protection with a partnership-style governance structure, and is often preferred by professional services firms. However, choosing a limited structure alone is insufficient — the relationship between the founders must still be regulated by a comprehensive written agreement.

Shareholders' Agreements and Partnership Agreements

A shareholders' agreement (for a limited company) or partnership agreement (for an LLP or traditional partnership) is essential. It should address: ownership and equity splits; how profits and losses are to be allocated; who makes which decisions and whether any decisions require unanimity; how disputes between founders are to be resolved; what happens if a founder wishes to exit, is incapacitated, or dies; restrictions on competition by departing founders; and intellectual property ownership. The agreement should also include pre-emption rights — the right of existing shareholders to buy a departing founder's shares before they are sold to a third party. Without pre-emption rights, you might find yourself in business with a stranger or a competitor.

Directors' Duties Under the Companies Act 2006

If the business is a limited company, all directors owe statutory duties to the company under the Companies Act 2006. These include the duty to promote the success of the company for the benefit of its members as a whole, the duty to exercise independent judgment, the duty to exercise reasonable care and skill, the duty to avoid conflicts of interest, and the duty not to accept benefits from third parties. These duties cannot be contracted out of. Breach of these duties can expose a director to personal liability even within a limited liability structure. If a director acts in their own interests at the expense of the company, or facilitates fraudulent trading, personal liability can follow.

Intellectual Property and Other Key Assets

Business founders frequently overlook intellectual property. If the business is built around a product, software, creative work, brand, or business method, the ownership of that IP must be addressed in the founders' agreement. Without an express agreement, IP created by an individual may belong to that individual personally rather than to the business. If that individual leaves the company, they may be entitled to take the IP with them — potentially destroying the business. The agreement should specify that all IP created in connection with the business is owned by the company (or partnership), and the founders should execute an IP assignment agreement. This is particularly important for technology businesses.

⚠ Disclaimer: This article is for informational purposes only and does not constitute legal advice. Starting a business involves complex legal, tax, and commercial considerations that are unique to each situation. You should seek advice from a qualified solicitor before entering into any business arrangement.

Contact Duan & Duan UK LLP — Duan & Duan UK LLP advises entrepreneurs and business founders on company formation, shareholders' agreements, partnership agreements, and corporate governance. Before starting a business with friends, contact us to ensure the right protections are in place from day one.