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What’s it: A partnership is a business organization in which two or more parties work together and combine resources to advance their common interests. Each party, referred to as a business partner, agrees to share the risks, responsibilities, profits, and losses. They can be individuals, businesses, or other organizations. Examples of partnerships are often found in services such as law firms, doctors, and accounting.
Key features of a partnership
Partnerships allow owners to share profits, liabilities, and management. It is also possible to combine their entrepreneurial qualities and expertise by collaborating and working together.
Each partner agrees to establish and operate a joint business with their respective investments and, usually, joint responsibilities. The arrangement is contained in a legal document (called a partnership agreement or partnership deed), which details how the business will be run, for example, concerning:
- Provisions regarding equity participation.
- Provisions for profit sharing (loss) for each partner.
- Distribution of salaries or wages of each partner.
- Partner rights and obligations.
- Decision-making.
- Other provisions and procedures such as regarding if the partner leaves or the partnership is dissolved.
Then, depending on the type, some partners may have unlimited liability. Meanwhile, other partners have limited liability and only contribute to capital.
Features of a partnership
A partnership is a business structure where two or more parties join forces to operate a venture. Here’s a closer look at the defining features of partnerships:
- Multiple owners: At the core of a partnership lies the presence of at least two individuals or entities acting as co-owners. These owners, known as partners, share responsibility for the business’s success.
- Formal or informal agreements: While a partnership agreement is not always mandatory, it’s a highly recommended practice. This legal document outlines critical aspects like profit sharing, decision-making processes, and partner responsibilities. Its well-defined partnership agreement helps ensure clarity and prevent future disputes.
- Shared management and responsibilities: Unlike a sole proprietorship, where one person controls everything, partnerships involve shared management. Partners typically divide responsibilities based on their skills and expertise. The specific roles and decision-making procedures are often documented in the partnership agreement.
- Profit and loss sharing: A fundamental feature is the sharing of both profits and losses. Partners distribute the business’s net income according to the terms of their agreement. Similarly, they share the financial burden of any losses incurred by the business.
- Limited transferability of ownership: Unlike publicly traded companies, partnerships generally restrict the transfer of ownership interests. A partner cannot simply sell their share of the partnership to another party without the consent of the other partners. This helps maintain stability within the partnership structure.
- Pooled resources: Partnerships function by pooling capital and other resources from each partner. These can include financial investments, expertise, and business networks. Combining resources allows them to potentially access greater funding and capabilities compared to sole proprietorships.
Types of partnerships
Generally, partners fall into two categories:
- General partners. They are actively involved in day-to-day operations and making business decisions. Regarding liability, they have unlimited liability.
- Limited partners. They are not involved in managing day-to-day operations. They only donate money and have limited liability, according to their investment.
Furthermore, this type of partnership can take the following organizational forms:
- General Partnership
- Limited Partnership
- Limited Liability Partnership (LLP)
- Limited liability limited partnership (LLLP)
General Partnership
The most basic is the general partnership. It involves two or more individuals sharing ownership and management responsibilities. Partners have equal rights in decision-making and control over the business.
A key feature of general partnerships is unlimited liability. This means each partner’s personal assets are on the line if the business encounters financial difficulties. For instance, if the organization defaults on a loan, a creditor could seize a partner’s personal car or house to satisfy the debt.
General partnerships are often formed through informal agreements and do not require complex registration processes. This makes them a simple and inexpensive way to establish a business.
However, the lack of a formal agreement can lead to disputes down the road. Having a written agreement outlining profit sharing, decision-making processes, and partner responsibilities is highly recommended.
The lifespan of a general partnership is often tied to the involvement of its partners. If a partner dies, leaves the partnership, or declares bankruptcy, the partnership may automatically dissolve.
Limited Partnership
A limited partnership offers a way to bring together partners with varying levels of liability and involvement. There are two types of partners in a limited partnership:
- General partners: These partners have unlimited liability for the partnership’s debts and obligations, similar to a general partnership. They also actively manage the day-to-day operations of the business.
- Limited partners: Limited partners contribute capital to the partnership but have limited liability, typically only up to the amount of their investment. They are not involved in managing the business and have limited voting rights.
Limited partnerships must be formally registered with the state. A partnership agreement outlining the rights and responsibilities of each partner type is essential. This agreement helps ensure clarity and prevent future conflicts.
Limited Liability Partnership (LLP)
An LLP offers all partners limited liability protection for the business’s debts and obligations. This provides greater personal asset protection compared to a general partnership. LLPs are particularly popular among professionals such as lawyers, accountants, and architects, where individual partners could face malpractice lawsuits.
Like general partnerships, LLPs involve partners actively managing the business and sharing decision-making responsibilities. Establishing an LLP typically requires more complex legal formalities compared to a general partnership.
Limited liability limited partnership (LLLP)
This is a relatively new and uncommon form of partnership structure, existing only in a limited number of US states. Similar to a limited partnership, an LLLP has general partners and limited partners.
However, unlike a limited partnership, even the general partners enjoy limited liability protection. This offers a unique combination of features, allowing for active management by general partners while shielding their personal assets from liability.
Advantages of partnerships
A partnership is easier and cheaper to run than companies. Unlike a sole proprietorship, which is designed for individual entrepreneurs, it allows for larger business operations with each partner contributing. Other advantages are:
- Simpler and lower costs: Compared to corporations, partnerships are easier and cheaper to form and operate. Unlike sole proprietorships, which limit ownership to a single individual, they allow for larger business ventures with contributions from multiple partners. This translates to potentially greater access to resources and expertise.
- Reduced complexity: Partnerships generally have fewer legal formalities compared to corporations. While a partnership agreement is recommended, registration requirements can be less stringent depending on the type. This translates to less government regulation and simpler business documentation.
- Greater resources: A key advantage is the pooling of resources from multiple partners. This can involve both financial capital and expertise, exceeding what a single entrepreneur could bring to the table. Additionally, partnerships may find it easier to secure external funding from banks compared to sole proprietorships.
- Reduced stress and shared workload: Distributing responsibilities and decision-making among partners alleviates the pressure on any one individual. This can significantly reduce stress compared to sole proprietorships, where the owner shoulders all business burdens. Limited partners enjoy the benefit of contributing capital without being actively involved in day-to-day operations.
- Diversity of skills and expertise: Partnerships can leverage the unique skills and knowledge of each partner. This creates a synergy where partners can overcome weaknesses and contribute to better decision-making and overall business success.
- Enhanced quality of decisions: By sharing roles and expertise, partnerships can develop higher-quality business strategies and make more informed decisions.
- Simpler tax structure: Partnerships avoid the double taxation faced by corporations. While the partnership itself doesn’t pay corporate income tax, individual partners report their share of the profits on their personal tax returns, simplifying accounting procedures.
- Shared risks and losses: The financial risks and liabilities associated with the business are distributed among partners according to the partnership agreement. Similarly, profits and operational responsibilities are shared amongst all partners.
Disadvantages of partnerships
Partnerships are designed to spread risk and management among individual entrepreneurs, as opposed to sole proprietorships, which are concentrated in one person. However, it also carries its own risks. Here are the partnership disadvantages:
- Unlimited liability (for some partners): In certain partnership structures, particularly general partnerships, some partners may face unlimited liability for the business’s debts and obligations. This means their personal assets could be seized to satisfy business debts if the partnership cannot meet its financial commitments. Limited partners typically have limited liability, but it’s crucial to understand the specific terms of the partnership agreement.
- Mutual dependence: The actions and decisions of each partner can significantly impact the entire partnership. A mistake or poor judgment by one partner can incur losses or damage the reputation of the business, affecting all partners. Careful selection of partners with compatible goals and strong work ethics is essential to mitigate this risk.
- Slower decision-making: Reaching consensus among multiple partners can be a time-consuming process compared to sole proprietorships. Open communication and a well-defined decision-making process outlined in the partnership agreement can help streamline this process. However, disagreements and potential stalemates are more likely to arise in partnerships compared to a single owner making unilateral decisions.
- Limited funding potential: Partnerships generally have access to less capital compared to corporations. They are typically limited to personal investments from the partners and may find it more challenging to secure external funding through issuing stocks or bonds. This can restrict their ability to grow or expand the business.
- Potential for disruption: The lifespan of a partnership can be shorter than other business structures. Disagreements between partners, changes in personal circumstances, or even the death or departure of a key partner can lead to the dissolution of the partnership.
- Profit sharing: Profits are distributed among partners according to the partnership agreement. This can result in each partner receiving a smaller share of the profits compared to a sole proprietor who keeps all the business earnings.
- Unequal profit distribution: Profit-sharing ratios are not always equal. The partnership agreement may allocate a larger share of profits to senior partners who contribute more experience or capital, while junior partners may receive a smaller percentage despite contributing their skills and effort.
