Partnership: What is it, Pros and Cones in 2024

When at least two persons jointly own a business, that business is said to be in a partnership. The maximum number of partners is typically 20, however, there are occasional exceptions, such as accountants and lawyers.

A business that is co-owned by two or more people is referred to as a partnership. The co-owners of the business are called partners and they collectively form the ‘firm. The partners agree to divide the gains and losses of a joint enterprise, either verbally or ideally in writing.

Partnership Agreement

To avoid future disputes between the partners, a written partnership agreement outlining the terms and conditions of the partnership is advised. These contracts often define the partnership’s name, its objectives, and the contributions made by each partner (financial, asset, skill/talent, etc.). It also describes each partner’s roles and obligations as well as their pay agreements (salary, profit- and loss-sharing, etc.). It should include clauses for adding new partners, selling partnership interests, and following processes for resolving disputes, closing the company, and distributing the assets.

General partnerships and limited partnerships are the two fundamental forms of partnerships. Each member in a general partnership is liable for the full amount of the company’s debts. Professionals such as lawyers, accountants, and architects combine in the form of general partnerships.

Limited Liability Partnership

In a limited partnership, there must be at least one general partner with unlimited liabilities and at least one limited partner with liability that is limited to the amount invested in the company. Limited partnerships are used for risky investment initiatives where there is a high potential for loss. The risk of loss is borne by the general partners; the limited partners’ losses are limited to their initial investment. Unlike general partners, limited partners must abide by the conditions of a partnership agreement and still receive a portion of the profits of the business. Usually, the general partner receives a larger share of the profits after the limited partners have received their initial investment back.

There are also Limited liability partnerships (LLP), which are comparable to general partnerships but partners are not held responsible for the debt and obligations of the business.

Advantages of Partnerships

Ease of formation. Partnerships are simple to set up, just like a sole proprietorship. The partners decide to form a partnership agreement and run the business together. The majority of partnerships fall under simple legal regimes.

Higher availability to raise funds. Partnerships have the benefit of a combination of talents and skills and pooled finances Due to their increased reputation, the partners’ combined financial power also improves the business’s ability to raise money from other sources.

Combined Knowledge and Skills. The management and operation of the company are shared by the partners. The likelihood of the partnership succeeding is increased by combining the partner’s skills to define goals, control the overall direction of the business, and resolve issues. The diversity of skills in a partnership makes it possible for the business to be run by a management team of specialists instead of by a generalist sole proprietor. With their respective specializations, a wide variety of customers can be served. For example, an accounting firm may have one partner who specializes in personal taxes for individuals. And another who specializes in corporate taxes for firms. A medical practice partnership may have doctors with various types of expertise.

Flexibility of decision making. Partnerships can react more quickly to changes in the business environment than large corporations. Such fast reactions are possible because the partners are involved in day-to-day operations and can make quick decisions after consultation.

Less Regulatory Control. Like a sole proprietorship, a partnership has fewer regulatory controls affecting its activities than does a corporation. A partnership does not have to file public financial statements with government agencies or send out quarterly financial statements to several thousand owners, as the corporations do such as Unilever and Pakistan State Oil.

Disadvantages of Partnerships

Unlimited Liability. All general partners have unlimited liability for the debts of the business. As with sole proprietorships, business failure can lead to a loss of the general partners’ assets. To overcome this problem, many countries now allow the formation of limited liability partnerships (LLPs), which protect each partner from responsibility for the acts of other partners and limit their liability.

Sharing of profits. Any profits that the partnership earns must be divided among all partners with an agreed ratio. As a result, the higher the number of total partners, the smaller the share of each partner. Sharing the profits is relatively easy if all partners contribute equal amounts of time, expertise, and capital. But if one partner puts in more money and others more time, it might be more difficult to arrive at a fair profit-sharing formula.

Difference of opinion. In contrast to combined knowledge and skills, the diversity of partners may result in serious disagreements for key business decisions such as how to run their business, which employees to hire, how to allocate responsibilities, and when to expand. Such diversity in personalities and work styles can cause clashes or breakdowns in communication, sometimes requiring outside intervention to save the business.

Dissolution of partnerships. As a rule, partnerships are easier to form than to leave. When one partner wants to leave, the value of their share must be calculated. It is always difficult to decide who is going to acquire the shares of a leaving partner, and if that person is acceptable to other partners. If a partner who owns more than 50 percent of the entity withdraws, dies, or becomes disabled, the partnership must reorganize or end. To avoid these problems, most partnership agreements include specific guidelines for transferring partnership interests and buy–sell agreements that make provisions for surviving partners to buy a deceased partner’s interest.

Frequently Asked Questions