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.
Partnership features
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 of partnership, some partners may have unlimited liability. Meanwhile, other partners have limited liability and only contribute to capital.
Following are the features of a business partnership:
- This business organization has at least two or more owners.
- Establishing a partnership can be through a formal partnership agreement or not.
- Partnerships are generally not considered separate legal entities.
- Partners share in management and responsibilities, depending on the agreement and the type of partnership.
- Partnership interests are not freely transferable.
- Capital and profits (risk) are pooled and shared among partners.
Partnership types
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, type of partnership can take the following organizational forms:
- General Partnership
- Limited Partnership
- Limited Liability Partnership (LLP)
- Limited liability limited partnership (LLLP)
General Partnership
A general partnership is the basic form of partnership. Partners share profits equally. Likewise, financial and legal obligations are equally divided between them, for which they have unlimited liability. Each partner has the same rights in managing, making decisions, and controlling the business. However, it all also depends on the agreement, which may set different terms.
General partnerships often come through informal agreements and do not need to be registered as a business entity. Thus, they are easy to form and dissolve. Often, they disband automatically if a partner dies or goes bankrupt.
Limited Partnership
A limited partnership is registered as a formal business entity. It involves general partners and limited partners. As I mentioned earlier, both have different responsibilities regarding debts and obligations. General partners have unlimited liability. Meanwhile, other partners have limited liability.
Limited Liability Partnership (LLP)
LLP has several elements of partnership and corporation. Each partner has limited liability. They are also not responsible for any other partner’s financial and legal misconduct. In running the business, each partner is actively involved in managing and making business decisions. This form of organization is common for professions such as lawyers and accountants.
Limited liability limited partnership (LLLP)
LLLP is a newer form of business partnership. This business organization operates like a limited partnership with general partners and limited partners. The general partner actively manages the business but has liability protection, unlike in a limited partnership.
This business organization can be found in several states of the United States, such as Washington, North Carolina, and Texas.
Partnership advantages
Partnerships are easier and cheaper to run than companies. Unlike a sole proprietorship, which is designed for individual entrepreneurs, partnerships allow for larger business operations with each partner contributing. Other partnership advantages are:
Relatively simple. Partnerships do not always have to be registered and have legal formalities, depending on the type. Thus, business is relatively free from government control.
Less complex. Apart from the partnership agreement, business-related documents are relatively minimal, unlike a limited liability company.
Greater resource. Unlike a sole proprietorship, capital investment comes from several people, not just one person. Then, access to external funding such as borrowing from a bank can be easier than a sole proprietorship.
Less stress. Partners share responsibilities, day-to-day managing operations, and making business decisions. As a result, it’s less stressful than operating as a sole proprietorship, where the owners have to take on different roles within the business. In fact, for limited partners, they do not have to be actively involved in operations but only contribute funds.
More variety. Different partners can bring different skills and expertise, including entrepreneurial expertise, into the business. As a result, they can synergize and overcome each other’s weaknesses to achieve mutual success.
Quality. Sharing roles and expertise, for example, enables better quality business decisions and business strategy development.
Single tax. Partnerships do not pay corporate taxes. On the other hand, the partner who manages the business pays personal income tax. It makes accounting simpler.
More dispersed losses and risks. Each party has responsibility for debts and risks, depending on the partnership agreement. Likewise, profits and operations are shared between them.
Partnership disadvantages
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. It specifically refers to limited partners, where they assume unlimited liability for the obligations and debts of the business.
Mutual dependence. For example, mistakes and bad decisions by one of the partners can damage the interests of the other partners and are considered the responsibility of all of them. For this reason, it is important to choose business partners carefully.
Longer decision. Business decision-making can take longer than a sole proprietorship. Each partner needs to discuss before making a decision. And it could end in a stalemate if disagreements arise. It differs from a sole proprietorship, where decisions are taken by one person (the owner), so there is no need for consensus.
More limited. For example, funding is still relatively limited compared to a limited liability company. In addition, businesses don’t have access to capital markets, so they can’t raise money from stocks or bonds.
Shorter age. Sometimes, differences in interests cause the partnership to end. Also, the business can stop when the main partner dies.
Profit-sharing. Profits are shared among partners, depending on the agreement. So, less money goes to each partner. In contrast, in a sole proprietorship, the business profit is the owner’s profit.
Profit-sharing inequality. The profit-sharing ratio is not necessarily equal, depending on the agreement in the partnership deed. For example, in a professional partnership, generally, the senior partner gets a more significant share. They also do a smaller percentage of routine work than junior partners.