Partnership: Advantages and Disadvantages

Partnership: Advantages and Disadvantages

A partnership is a legal form of business in the United States with two or more persons as owners. The Uniform Partnership Act of the United States defines this business form as an association of two or more individuals to act as co-owners of a business. Similar to a sole proprietorship, the law does not distinguish between the business and its owner.

The partnership agreement is a legal agreement that serves as a blueprint for making business decisions, distributing and sharing profits, resolving disputes, the inclusion of future partners, exclusion of current partners, and dissolution of the entire business.

Three Specific Forms of Partnership in the United States

Depending on the distribution of management responsibilities and liabilities, there are three forms of partnership in the United States. Below is a quick overview:

• General partnership: A general partnership is a form of partnership in which partners share equally in responsibility and liability. These partners or owners are general partners. This means that they have shared responsibilities and liabilities. A general partner assumes unlimited liability for the debts of the business, including the debts incurred by another general partner.

• Limited partnership: A limited partnership is a form of partnership that involves one general partner who assumes full responsibility and liability and limited partners who have limited responsibility and liability. This limitation usually depends on the percentage of investment.

• Limited liability partnership: A limited liability partnership is a form of partnership in which all partners have limited liabilities, and the entire business has no general partner. Each partner is not personally liable for the acts of fellow partners. They are also not personally liable for the debts and contractual obligations of the business.

Advantages of a Partnership as a Form of Business in the U.S.

1. Easy and low cost to form

Compared to limited liability companies and corporations, and similar to sole proprietorships, a key advantage of a partnership is that it is relatively easy and inexpensive to form. General legal and documentary requirements center on registering a business name and securing required licenses or permits. The majority of time spent putting up this form of business is focused on developing the business agreement.

2. Access to capital and credit

An owner of a sole proprietorship carries the sole burden of raising capital or securing credit. In a partnership, however, partners pool their funds and assets to have more capital that would otherwise be unavailable to a single proprietor. Each partner can also secure a personal loan depending on his or her credit standing. Access to funds to establish and finance a business is another notable benefit of choosing a partnership over a sole proprietorship.

3. Direct retention of profits

Unlike in a corporation, and similar to a sole proprietorship, U.S. laws mandate that all profits belong to the partnership owners. Ownership of earnings can help motivate partners to work diligently to build, maintain, and improve further the profitability of their business. However, the division of profit among partners depends on the partnership agreement.

4. Complementary capabilities

Partners essentially combine their resources, skills, and knowledge to form and operate the business. Another advantage of a partnership is that each partner can complement the capabilities of one another. The strength of one partner offsets the weaknesses of other partners. Decision-making becomes a shared responsibility. Hence, this can serve as a source of competitive advantage over sole proprietorships.

5. Possible tax advantage

Similar to sole proprietorships, the business can also enjoy certain tax advantages, unlike corporations, because it is not taxed separately from the owners. The personal income of each partner is the basis for taxation. Furthermore, in several states, a business registered under this form is also free from paying special taxes such as franchise taxes for limited liability companies and corporations.

Disadvantages of a Partnership as a Form of Business in the U.S.

1. Jointly and individually liable

Partners in a general partnership are jointly and individually liable for the actions of other partners. Each partner or each general partner is personally liable for all the debts and obligations of the business. The government or creditor may cease the personal assets of the general partners if the asset of the business is insufficient to pay debts or other obligations. General partners have unlimited liability. This is a considerable disadvantage of partnership over limited liability companies or corporations. However, note that limited partners risk only their original investments and existing business assets.

2. Management disagreements

Disagreements among business owners or members of the top management are inevitable. However, in a partnership, severe instances of disagreements might hamper the operation of the business or result in its termination. Remember that not all partnerships work. Some situations make sole proprietorship advantageous. Partners may have competing interests, unique preferences, and irresolvable directions. Severe differences among partners can result in personal resentment, decision deadlocks, or business dissolution.

3. Determining profit shares

Dividing and distributing profits might become an issue among partners. Specifically, this is true when one or more partners feel that some of their co-owners are not deserving of what they are getting or are contributing less to the operability and profitability of the business. Unequal contribution of time, effort, and resources might become a source of conflict and a cause of a heated discussion over profit sharing.

4. Problem with continuity

Another disadvantage of partnership is that the business will terminate if any one of the partners dies or leaves. The bankruptcy of the partner will also terminate the business. However, the remaining partners can purchase the share of the leaving partner. While U.S. law generally prescribes discontinuity due to a partner leaving the business, a partnership agreement can remedy this by detailing actions for continuity or other contingency actions.

5. Getting out of the partnership

Pulling out an investment or quitting the business might be difficult, especially if the remaining partners are unwilling to buy the share of an individual partner who wants to retire or quit for other reasons. A partnership agreement can remedy this scenario by providing a proper exit or buyout procedure. Hence, it is essential for partners to determine, establish, and implement mechanisms for effective and efficient transitions and successions.