Silent Partnership and Its Use in Practice

What is a silent partnership and when does it make sense?

A silent partnership is not a separate legal entity or a new business; it is merely a private contractual relationship between an entrepreneur and an investor. This allows it to remain "silent"—the investor's existence is not visible externally and does not appear in the Commercial Register or the company's registered capital. A silent partner can be a natural or legal person (not necessarily an entrepreneur), and the contribution does not have to be just money—assets, rights, or other values usable in the business can also be contributed.

A silent partnership allows a company to raise capital without a traditional loan and without the investor formally entering the ownership structure. In practice, it is used, for example, when an entrepreneur has a development project or is in temporary financial difficulty but does not want (or cannot) take out a bank loan and wants to retain full control over the company. A typical example: The company needs money for a new project, the bank will not provide another loan, and you do not want to offer an equity stake to an investor.

The solution can be a silent partner—an investor who provides capital in exchange for a share of the future business profits. The ARROWS law firm encounters many such situations in its practice, and its Prague-based lawyers regularly help set up silent partnerships so that the company can obtain the necessary funds discreetly while contractually protecting the investor. This method can be used to finance, for example, one-off development projects, production expansion, bridging a crisis period, or other business expansion—all without the existing owners giving up part of the company.

Silent Partnership vs. Loan and Direct Equity Investment

If you are considering a silent partnership, it is a good idea to compare it with alternatives—a traditional loan and a direct equity investment by an investor. Unlike a loan, a silent partner is not entitled to any fixed remuneration (interest). Their return depends purely on the entrepreneur's success—they receive payment only if the business makes a profit. This is riskier for the investor: if the company does not earn, they get nothing; if the business goes bankrupt, they can lose their entire invested capital.

Investors usually compensate for this higher risk by demanding a higher share of the profit than would correspond to a normal loan interest rate. From the entrepreneur's perspective, however, a silent partner is "cheaper" in bad times—unlike with a bank, you do not have to pay any interest or installments in loss-making years; you simply do not pay out a share of the profit. This can help a company survive a difficult period when regular loan repayments would be liquidating.

Compared to a traditional investor entry into the company (acquiring a share or stocks), a silent partnership has the advantage that the investor does not enter the company's ownership structure. The silent partner has no voting rights or formal influence on management—they remain anonymous externally. The share of existing owners is not diluted, and there is no need to change the entry in the Commercial Register. The entrepreneur thus retains full control over the company while raising capital.

For an investor, it can be attractive to share in the profits like a shareholder, but without all the corporate formalities and public publicity. A silent partner is also not liable for the entrepreneur's debts, as long as they remain truly "silent"—unlike an official partner, they bear no personal liability for the company's obligations (unless they breach the confidentiality condition). Their risk is limited to their contribution; they cannot be called upon to contribute more money beyond the contract.

Of course, a silent partnership also has its disadvantages compared to a direct ownership stake. The silent investor has no say in the company's management and must trust that the entrepreneur will run the business well and honestly report the results. The liquidity of such an investment is low—unlike a shareholder, a silent partner cannot simply "sell" their share on the market or transfer their participation without the entrepreneur's consent. Everything depends on the contractual arrangements; participation can usually be terminated by notice or agreement, but until then, the investor's money is tied up in the company.

From a tax perspective, a silent partner's share of the profit is similar to a dividend—the company must pay a 15% withholding tax on it. This tax is deducted when the profit is paid to the silent partner, and the company remits it to the state (for which it must be registered for income tax collected by withholding). ARROWS provides clients with a complete service in this area—we will explain the advantages and disadvantages of various financing forms and help choose the optimal option. The lawyers at ARROWS have experience in setting up silent partnerships as well as preparing traditional investor entries or loan agreements, so they can advise on what is most suitable for your project and how to handle everything legally and tax-wise.

Contractual Setup and Profit Distribution

A silent partnership is relatively simple to establish—it only requires a contract between the entrepreneur and the investor. The law does not even require written form, but we strongly recommend it. The silent partnership agreement must carefully define several key points: the amount and form of the contribution, the silent partner's share in both profit and potential loss, the duration of the silent partnership, termination options, and other rights and obligations of the parties.

The share of profit and loss can be agreed upon freely, but it must be of the same amount (ratio). It is not possible to agree that the silent partner would only share in the profit and not the loss, or vice versa—any such arrangements would be invalid. If the parties do not agree on the share amount, the statutory rule applies: the partner's share is determined by the ratio of their contribution and according to custom. For example, if they contribute 20% of the total capital, they are entitled to 20% of the profit (or bear 20% of any loss), unless otherwise agreed.

A well-prepared silent partnership agreement is absolutely crucial—it must anticipate various "what if" scenarios and protect both the entrepreneur and the investor. The contract can regulate special situations, such as the sale of the business or a change in the company's owner (a silent partnership typically terminates upon the sale of the company, but it can be agreed that the entrepreneur will pay out the silent partner preferentially from the proceeds of the sale, etc.).

It is also recommended to agree on how often the silent partner will have access to information—by law, they have the right to inspect the accounting records and receive the annual financial statements. The contract can also arrange for expanded control (e.g., quarterly financial reports) or, conversely, certain limitations. If the company wanted to avoid providing important data, it must have a very compelling reason—the silent partner has the right to verify that the profit for distribution is calculated correctly and honestly.

Profit distribution usually takes place once a year after the approval of the financial statements. If the entrepreneur fails to pay the profit share within the agreed or statutory period, they are in default, and the silent partner can demand default interest and potentially withdraw from the contract if the contract allows. The right to a share of the profit, of course, only arises if the company has made a profit—in loss-making years, the silent partner receives nothing.

What happens if the company first makes a profit and pays it out, but then falls into a loss the next year?

The received profit is not returned. The loss is reflected by reducing the value of the silent partner's contribution to the silent partnership. In other words, the loss eats into a part of the money the investor contributed to the company.

The new Civil Code abolished the obligation to replenish the contribution after a loss—so the silent partner does not have to return paid-out profits to the company or top up the contribution back to its original value. However, if the losses reach the full amount of the contribution, the silent partnership automatically terminates (unless the silent partner decides to replenish the contribution and thus "save" the project).

Upon termination of the contract, the entrepreneur is obliged to pay back the silent partner's contribution, increased or decreased by the business results as of the date of the contract's termination. In practice, this means the investor gets back what is left of their contribution (e.g., a contribution of CZK 1 million reduced by shares in losses). Therefore, it is important to also think about an exit strategy and have clear terms in the contract for when and how the partner can demand the return of their contribution.

The ARROWS law firm places emphasis on detail when preparing these contracts. Experienced lawyers will cover all essential arrangements in the contract and propose extra protective elements—such as a contractual penalty for concealing profits, a dispute resolution mechanism for differing accounting opinions, confidentiality clauses, simply everything that will protect your investments and business from unforeseen complications.

In addition to drafting or reviewing the contract, ARROWS will help you with all related documentation—they will prepare internal documents, legal opinions on unclear issues (e.g., tax implications), and of course, provide subsequent legal services, such as reviewing contract performance, consulting on profit calculations, or representing you in negotiations with the other party.

Entrepreneur's Insolvency: Risks for the Silent Partner

The biggest fear of any investor is that the company will go bankrupt. As mentioned, a silent partner has limited risk—they cannot lose more than they invested in the business. However, this does not mean they are not at risk in case of insolvency. On the contrary, in bankruptcy proceedings, the silent partner's claim stands behind other creditors.

The silent partnership agreement terminates upon the entrepreneur's bankruptcy, and the silent partner acquires the right to file a claim in the insolvency proceedings for the amount of their unpaid contribution (and any unpaid profit shares). However, they are practically an ordinary creditor—if there is not enough property to satisfy all claims, the silent partner often gets nothing. They are left only with what they may have previously received in profit shares.

For the investor, a silent partnership is therefore very uncertain in terms of guarantees—they have no security or preferential rights. This must be taken into account (higher return for higher risk). On the other hand, for the entrepreneur, this means that in case of bankruptcy, they do not have to pay the silent partner anything extra—the silent partner simply joins the ranks of other unsecured creditors.

Another risk for the silent partner stems from the human factor. If their participation in the business were to be revealed, they could lose their limited liability. The law states that if the silent partner's name is included in the company name, or if the silent partner publicly declares to business partners that they are in business together, they become liable for the entrepreneur's debts like any other partner.

This is an extremely dangerous situation—the silent partner could then be liable for all the company's debts without limit, with their entire personal assets. Fortunately, this risk can be relatively easily avoided by maintaining discretion. ARROWS lawyers always emphasize the need for strict confidentiality to clients and will help set up internal processes so that the investor's anonymity is not compromised (e.g., only a limited circle of people in the company knows the investor's identity, NDA agreements, etc.).

And how can a silent partner minimize the risks associated with insolvency? It is not possible to fully guarantee the return of the investment, but one can prepare in advance. For example, it is possible to agree in the contract that if economic indicators fall below a certain threshold, the silent partner has the right to terminate the contract and demand the return of their contribution before it is too late.

ARROWS knows how to incorporate such early-warning mechanisms into contracts. Furthermore, the investor can continuously monitor the financial management—e.g., by requesting regular financial reports to catch warning signs early. We can also help clients with this, including a legal assessment of financial statements or setting up control powers in the contract.

If bankruptcy does occur, ARROWS lawyers can represent the silent partner in the insolvency proceedings—they will file their claim, negotiate with the insolvency administrator, and ensure that the chance of any payout is maximized. At the same time, they can help the entrepreneur evaluate options for reorganization or other solutions to the crisis situation to avoid bankruptcy liquidation, which is the worst option for investors.

When to Turn to Experts

A silent partnership is an attractive investment tool that can connect entrepreneurs seeking financing with investors looking for a share of the profits. It brings mutual benefits—it provides the company with money without debt and loss of control, and it gives the investor a chance for an interesting return. At the same time, however, it places high demands on trust and careful legal treatment. If you are considering using a silent partnership, whether as an entrepreneur or an investor, we recommend consulting with experts.

The lawyers at ARROWS have extensive experience with these contracts—they will help you negotiate fair terms, prepare all documentation, and advise on how to minimize risks. Contact us, and we will discuss your situation individually. Together, we will find a tailor-made solution to ensure your silent partnership cooperation brings the expected results and is legally in perfect order.

Do not hesitate to contact the ARROWS law firm for a no-obligation consultation—we are here to help you safely evaluate your investments and grow your business.