A partnership form of business has several advantages and disadvantages, which we will discuss in this article. But first, let’s look at a brief introduction to this form of business.
A ‘partnership’ form of business organization is very common across the US. This form of business enterprise, in the simplest sense, is a formal agreement by two or more individuals to manage and run a business and to share its profits. A ‘general partnership’ is the easiest and the least expensive to form. All the partners share responsibility for the business and face unlimited liability for business debts. Each general partner must contribute something to the business (money, labor, property, etc.). Also, each partner reports the share of their profits as their personal income.
Advantages of Partnerships
Partnership business has several advantages, making it an attractive form of business. Below are the most important advantages.
In comparison with the sole proprietorship, in which the owner manages everything, a partnership form of business offers the benefit of collaboration. Running a business with your partners allows you to draw on the resources and ability of these co-partners. On the other hand, running a business on your own can be a challenge, especially when you don’t have all the expertise to run the business. So, when you have partners to share your responsibilities, you can share the risk, create mutual support, lighten your workload and maintain balance in your life.
The profits of a partnership pass to its owners, who report the profits as their personal income for tax purposes. Hence, profits are taxed only once rather than twice, as is the case with corporations. In the case of corporations, the profits are taxed first at the corporate level and then at the individual level when the dividend is distributed. So, partners enjoy more income out of the earnings of their business as against shareholders of a corporation.
Partnership firms are able to keep their business reports confidential. Unlike corporations, the law does not require partnership firms to publish business reports and financial statements in the public domain. These reports and financial statements have information about your sales growth, profit margins, business strategies, asset allocation, and many other things that can help your competitors to compete effectively.
More Partners, More Funds
Partners usually have an easier time getting funds than many other forms of business. First, since there are more individuals, you have a greater number of sources of funds. Second, since the profits of a partnership firm are taxed only once, partners get a higher income in their hands. This opens the possibility of partners investing more money out of their income as capital for the business. Third, since there are a greater number of individuals who run the business and hence, greater experience than a sole proprietorship firm, investors will perceive less risk in the business. So, they will be more likely to invest in a partnership firm.
Easier to Form and Run
In comparison with corporations, a partnership is easier to form and run. While forming a corporation is a time-consuming and hectic process, with lots of documents to be submitted and agreements to be signed, forming a partnership is pretty simple, with very few documents to be submitted to the regulatory bodies. Another major limitation of a corporation is that the laws governing them in the US vary from state to state. Also, these laws keep changing. In contrast, the federal Uniform Partnership Act provides a consistent set of laws across the US, making it easier to know them and comply with them.
Disadvantages of Partnerships
Along with the lucrative advantages a partnership firm offers you, there are some disadvantages of such a form of business. So, if you are considering getting into a partnership business, these disadvantages must be considered.
The members of a partnership firm get exposed to unlimited liability for the performance of the business. This means that if the business takes a lot of debt and then becomes incapable to pay them, or if an employee or a customer decides to sue the business, the partners run the risk of losing their personal assets to pay for the damages done by the business. Hence, before getting into partnership business, it is advisable to determine the assets that will be put at risk. If you possess valuable personal assets that you will not invest in the business, you may consider some other form of business that protects you from unlimited liability.
Differences and Conflict
By getting into a partnership business, you lose your autonomy to make decisions. With each partner having a say in the decisions, each partner must show flexibility and the ability to compromise. Despite compromising, some conflict of interest among the partners is always possible. E.g. some partners will dedicate every moment of their lives to growing and developing the business, and so they will expect others to do the same. Others, however, may want a balance in their life. At other times, some partners may have a higher risk-taking ability than others. So, partners with a higher risk-taking ability may recommend a risky project which others may find uncomfortable. Hence, the partnership business is full of differences and conflicts of interests among the members, which may never get resolved.
Slower Decision Making
In comparison with sole proprietorship businesses, the decision-making process is slower in partnerships. Since all the partners are a part of the business, you will need to consult and discuss matters with other partners before making a decision. In case other partners disagree with your decision, more time will pass in negotiating and building consensus. Sometimes, this may result in missing opportunities where the decision had to be taken on the spot. Also, this shared decision-making may frustrate a partner whose inputs always get rejected by others.
Lack of Continuity
Unlike corporations, which exist perpetually, continuity of business is a question in the case of partnerships. General partnerships dissolve if one of the partners dies, retires, or withdraws from the business. This may increase the risk of investing in partnership enterprises for those investors who invest with a long-term perspective. However, partners can overcome this limitation by adding a provision in the partnership agreement that allows buying out of a partner’s share in case they want to withdraw or if the partner dies. This transfer of ownership, however, also comes with some legal restrictions, which can again put the continuity in question.
In a general partnership, each partner is liable not only for their actions but also for the actions of the other partners. This implies that, if one of the partners commits fraud or any other illegal activity, the other partners will also be liable for his actions, especially in case the firm is given a monetary penalty. So, it becomes important for all the partners to know each other well and develop trust among themselves before getting into a partnership business.