Partnerships

Learning Objectives

  1. Identify the different types of partnerships, and explain the importance of a partnership agreement.
  2. Describe the advantages and disadvantages of the partnership form of organization.

A partnership (or general partnership) is a business owned jointly by two or more people. About 10 percent of U.S. businesses are partnerships, and though the vast majority are small, some are quite large. For example, the big four public accounting firms are partnerships. Setting up a partnership is more complex than setting up a sole proprietorship, but it’s still relatively easy and inexpensive. The cost varies according to size and complexity. It’s possible to form a simple partnership without the help of a lawyer or an accountant, though it’s usually a good idea to get professional advice. Professionals can help you identify and resolve issues that may later create disputes among partners.

Advantages and Disadvantages of Partnerships

Factors

Consideration

Start-up

 Fairly easy and cheap to form, though legal assistance is often helpful

Control

 Partners must share decision making

Benefactors

 Partners share profits

Taxation

 Partners pay personal income taxes on their share of profits; the partnership doesn’t pay any special taxes

Capability

 Can bring together a diverse group of talented individuals who share responsibility for running the business

Sustainability

 Partners can agree legally to allow the partnership to survive if one or more partners die

Financing

 The business can draw on the financial resources of a number of individuals

Liability

 Partners are subject to unlimited liability; each partner is personally liable not only for his or her own actions but also for the actions of all the partners. The law also permits a limited partnership, which has two types of partners: a single general partner who runs the business and is responsible for its liabilities, and any number of limited partners who have limited involvement in the business and whose losses are limited to the amount of their investment.

The Partnership Agreement

Partnerships are susceptible to conflicts and disputes since they require decision-maker to occur across all partners. The impact of disputes can be lessened if the partners have executed a well-planned partnership agreement that specifies everyone’s rights and responsibilities. The agreement might provide such details as the following:

  • Amount of cash and other contributions to be made by each partner
  • Division of partnership income (or loss)
  • Partner responsibilities—who does what
  • Conditions under which a partner can sell an interest in the company
  • Conditions for dissolving the partnership
  • Conditions for settling disputes

Limited Partnerships

Many people are understandably reluctant to enter into partnerships because of unlimited liability. Individuals with substantial assets, for example, have a lot to lose if they get sued for a partnership obligation (and when people sue, they tend to start with the richest partner). To overcome this defect of partnerships, the law permits a limited partnership, which has two types of partners: a single general partner who runs the business and is responsible for its liabilities, and any number of limited partners who have limited involvement in the business and whose losses are limited to the amount of their investment.

Key Takeaways

  • A general partnership is a business owned jointly by two or more people.
  • About 10 percent of U.S. businesses are partnerships.
  • The impact of disputes can be reduced if the partners have a partnership agreement that specifies everyone’s rights and responsibilities.
  • A partnership has several advantages over a sole proprietorship:
    • It’s relatively inexpensive to set up and subject to few government regulations.
    • Partners pay personal income taxes on their share of profits; the partnership doesn’t pay any special taxes.
    • It brings a diverse group of people together to share managerial responsibilities.
    • Partners can agree legally to allow the partnership to survive if one or more partners die.
    • It makes financing easier because the partnership can draw on resources from a number of partners.
  • A partnership has several disadvantages over a sole proprietorship:
    • Shared decision making can result in disagreements.
    • Profits must be shared.
    • Each partner is personally liable not only for his or her own actions but also for those of all partners—a principle called unlimited liability.
  • A limited partnership has a single general partner who runs the business and is responsible for its liabilities, plus any number of limited partners who have limited involvement in the business and whose losses are limited to the amount of their investment.