Partnership Advantages and Disadvantages: Everything You Need to Know
Partnership advantages and disadvantages are the benefits and drawbacks of starting a partnership over another type of business, such as a sole proprietorship.8 min read
What are Advantages and Disadvantages of a Partnership
Partnership advantages and disadvantages are the benefits and drawbacks of starting a partnership over another type of business, such as a sole proprietorship.
When it comes to types of businesses, sole proprietorships are the easiest ones to start, especially since the business is the person who starts the organization. This sole proprietor is the person who receives all of the profits of the business as well.
Sole proprietorships require very little capital to begin, and there are no fee structures when it comes to filing paperwork. Also, there is very little documentation that you need to fill out and file. When it comes to the business, its practices, and general operations, you will be able to make all choices as the sole proprietor. You will need to pay your own person taxes on the profits you receive from the business though.
As the owner, you are directly liable for any injuries or wrongdoings of the business. Additionally, you are financially responsible for loans and debts if the business does not succeed. In fact, your personal assets can be directly acquired to pay back debts.
Sole proprietorships are typically quite small, especially since you may be limited in the amount of capital you can come up with for the business. You may need to use your own funds as well as money provided from friends and family members.
In the event of your death, the business may dissolve. If a family member or heir decides to keep the business, it will be transferred in this other individual’s name, and a new sole proprietorship will be formed.
Partnerships are different from sole proprietorships because a single person does not run the business. Instead, two or more people will own, run, and finance the business operation. In the case of the partnership, the law separates the individual owners and their assets from the business.
Partnerships may be limited varieties where there is one individual who is the general owner or primary partner. Other partners will be owners of the business as well but in a more limited scope. In general, the primary partner is the person who runs the business and oversees operations while the limited partners are the ones who provide financial backing for the business.
If you are a limited partner, then you have little to no say in the way that the business is actually run on a daily basis.
Like sole proprietorships, partnerships are relatively easy to form. While this is true, it is wise to take some time drafting the initial agreements between the individual partners. There are specific laws that regulate how you need to develop the partnership. For example, the Business Organizations Code ("BOC") Title 4 is what you would need to reference in the state of Texas.
Types of Partnerships
There are a variety of different partnership types that you should understand. These are:
- General Partnerships – This type of partnership involves two or more members who are equally responsible for all aspects of the business. This means that individuals are equally liable under the law when it comes to debts. Also, all partners are liable of the actions of partners in terms of the things that occur as business is conducted.
- Family Partnerships – These are general partnerships that involve a business started with two or more members of the same family.
- Limited Partnerships – The partnership is one where there is a single person who is in charge of the business. The other partners offer financial support and limited say in operations.
- With limited partnerships, the liability of the partner providing financial backing is directly proportional to the funds that are provided to the business. Specifically, there can be several limited partners, but the individuals who provide the most money will be liable in cases where the partnerships dissolves and debts need to be repaid.
- Incorporated Limited Partnership – This type of partnership involves a corporation through the partnership. The incorporation itself is its own separate business with its own legal standing. In the case of an ILP, the business must meet its own financial obligations as a company. However, if it fails to do so, the partners must step in and settle debts. Typically, the general partner does this.
Advantages of a Partnership
There are a wide variety of advantages to forming a partnership. The most substantial is the fact that the business is not required to pay income taxes. Each partner needs to claim the profits and expenses of the business on their personal tax forms.
Partnerships are easy to establish, and much more so than other business structures. Since partnerships are formed with a variety of members, individuals typically find it easier to raise capital for the business. Also, the various members bring their own experiences, skills, and knowledge to the company, and this can create a more successful business entity. With more people involved in the partnership, you will experience a greater ability to manage operations.
While ILPs are a bit more complicated and expensive to set up, most of the other types of a partnerships require very few fees. Partnerships establish a single unified business between two sole proprietors who want to run a successful enterprise. In essence, both partners benefit from each others business experience.
There are some tax benefits that are offered, especially to people who want to form family partnerships. Partnerships also allow for more diverse investment opportunities for individuals who want to provide capital for a business operation. With the partnership, the investor also benefits from limited liability.
If for some reason you want to change the type of business that you own, you can establish a corporation or other types of business after creating the partnership. In fact, this is relatively easy.
Liability is a term used to describe the exposure one experiences if a business becomes insolvent or cannot pay back its debts. In the partnership, partners are exposed where personal assets can be seized to pay back debts if the business itself cannot do so.
The liability and the partnership role cannot be directly transferred to another individual unless all of the other members in the partnership agree to it. In other words, you cannot find a replacement for your stake in the business unless the other partners say that you can do so. This means that you may be liable for the business and its debts until it dissolves.
Also, you should know that the partnership will dissolve automatically under certain circumstances. These include:
- The death of a partner
- The resignation of a member
- The retiring of an individual
- A bankruptcy filed by a partner
When a traditional and general partnership is formed, all members have an equal stake in terms of authority. All partners are called partners without a hierarchy between the individuals. When it comes to business transactions, others will see each partner as able to enter into contracts and business agreements willingly in the name of the partnership. Since all members retain the same stake in the business, this means that all members are liable for the possibly poor agreements made by a member.
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When you think about starting a business, whether you want a partnership, LLC, or sole proprietorship, it is wise to understand the various benefits and drawbacks of each business type with the help of a professional.
Disadvantages of a General Partnership
One of the largest disadvantages of developing a general partnership is the fact that all individuals are liable together for the decisions, debts, and obligations of the partnership. This includes legal problems like breach of contracts and torts. Also, a single partner can be sued in relation to the business by another person or a business, and in effect, all of the partners are liable for the outcome of the lawsuit.
In terms of liability, the fact that personal assets can be seized to settle the debts of the partnership is seen as a major drawback. Basically, each member is personally liable for the failure of the business. The inability to transfer the partnership without the express knowledge and permissions of all partners is a negative as well.
Partnerships are not completely stable business entities since the business can completely dissolve based on a retirement or death of one member.
When this type of business is formed, each member may not have specific duties and responsibilities. This can create a fairly vague business structure within the business itself and also to the public. Even if one member is not as involved in the business, profits are shared evenly regardless.
Disagreements are common amongst the partners since all individuals have an equal say in decisions. If disagreements, situations, or expectations change within the partnership, then this can create a complete split up of the business itself.
Advantages of a Limited Partnership
Limited partnerships have some unique advantages, like the reduced liability when it comes to lawsuits, contract disputes, and debts. The limited partner is basically only liable for the amount of money or capital that is invested in the business. No personal assets can be touched if debts are not paid.
Limited partnerships find it simpler to garner capital through investors. The businesses are attractive to the investors based solely on the limited liability of the investment in terms of debts. Any profits that are made are directly passed on to the investors, and the profit is placed on personal tax forms.
Limited partnerships mean that individuals can acquire the profits of the business without having to do the work of actually attending to business responsibilities.
Disadvantages of a Limited Partnership
If a limited partner wants to start taking part in business activities, there is a chance that they will become a general partner instead of a limited one. Personal liabilities are then acquired, and you will be responsible for debts, like the rest of the partners.
To reduce this issue, you should retain a Certificate of Limited Partnership. Each state government has their own paperwork that you can fill out and file with the state. You should do this before the partnership begins, so you know that you are protected with limited liability.
Keep in mind that you will need to pay a fee to file the document.
Corporations are separate from sole proprietorships and partnerships. The businesses are their own distinctive institutions with their own legal requirements and taxes. Corporations are started by people called shareholders who provide capital so they can receive stock in the company.
Corporations are completely separate entities from the people who run and oversee the operations of the business.
Advantages of a C Corporation
Corporations are easier to start since money is acquired from multiple sources and pooled together.
The individual shareholders who offer the capital are not liable for any debts or obligations of the business. Each investor may lose their capital in the event that the business dissolves, but no personal assets can be touched.
Documents must be filled with the state to form the corporation and there is typically a filing fee. The profits of the organization are then taxed as a corporation. The tax status is much different than a personal one. When individual shareholders are provided with their dividends, the money is taxed once again.
If a shareholder owns a great deal of stock in the business, then they will be able to voice an opinion in regard to the way the business is managed and operated. This is advantageous to some individuals who want to involve themselves in a business without actually retaining the liability of being a partner.
If you need help with developing a partnership or corporation, or if you are concerned about your specific liability issues with your business operation, then post a job on the UpCounsel marketplace. We work with the top lawyers in the country who have retained their legal degrees from such universities as Harvard and Yale.