Pros and Cons of a Partnership: Everything You Need to Know
Partnerships are a legal structure for a business in which partners report the profits and losses of the business.8 min read updated on February 01, 2023
Pros and cons of a partnership are the advantages and disadvantages of a legal business entity in which partners report the profits and losses of the business on their own tax returns while remaining responsible for the partnership's liabilities. It is a flexible structure with many benefits and drawbacks.
What Is a Partnership?
Partnerships are companies owned by at least two individuals, the partners, who provide capital and manage the business. In exchange, the partners receive a share of the partnership's profits and losses. You should be aware of which structure is best for your business before forming it as a partnership.
First, create a partnership agreement between you and the other partners. Even though the law doesn't require you to do so, this agreement will set certain ground rules for how the partnership will operate and will be very useful. A partnership agreement should:
- Set up the operating procedures of the company.
- State how the partnership's earnings will be given to partners.
- State how conflicts will be settled.
- State how new partners are created.
- State how the partnership might close.
The partnership should also be clear about the rights and responsibilities of each partner, particularly in regard to business decisions. The partnership will also need to specifically state how much capital each partner is providing to the company.
A partnership is a very useful business form for many companies, largely because it allows you to work with others who will be just as invested in the company as you due to the way the partnership is structured. If the partnership is designed badly, you can run into problems very easily.
You will need to plan ahead and be aware of potential problems and conflicts. With proper organization and planning, the partnership can be very useful for your business.
Partnerships are a simple and low-cost business model. They are usually longer-lived than sole proprietorships. However, a partnership is not the best structure for every company, depending on the people and factors involved. You should particularly be careful with who you choose as the other partners in the business.
When finding your business partners, you will need to see what kind of character and skills they bring to the table. They should have similar goals and beliefs, be good communicators, and bring skills and ideas to the company that you may not have. Communication and trust are particularly important in a partnership.
Before creating your partnership, you should think about who your partners will be. Make sure you are very familiar with your partner's background. Furthermore, remember that a business relationship is very different from a friendship.
Because a partnership is easier to form than to break, be very careful about whom you choose to partner with. You will also likely want to find legal and accounting services to assist you with starting the partnership properly.
Partnerships are particularly beneficial for those who wish to create a business but don't have the capital, manpower, and skills to do so on their own. Many business owners who want to bring together people of different skill sets and backgrounds should consider a partnership structure.
Are You the Business Partner Type?
Business partners have to work with each other. If you are used to making decisions on your own, you may initially find it difficult to work with multiple decision-makers. In a partnership, the partners may sometimes disagree over how much each partner is working for the partnership and what they are doing. Partnerships might not be right for you if you cannot deal with this kind of situation.
A general partnership has at least two partners who each work as part of the company. It is a default structure where liabilities and profits are distributed evenly to partners. Partnership income and deductible losses are taxed on each person's individual tax return, rather than in the business itself.
The tax-benefits of partnerships are one of their most distinctive features. Pass-through taxes are easy to calculate: all of the business's income and expenses are put on your personal tax return instead of the business's.
Partnerships are also simple, flexible, and less costly and complicated to create than limited partnerships or corporations. In terms of organization, partnerships have the freedom to be centralized or decentralized. Another major benefit of partnerships is that it allows people of different backgrounds to pool together their skills and money for the business.
However, partnerships also have many drawbacks, mostly regarding personal liability for the company's debts and other obligations. Each partner is personally responsible for those of the business and other partners in the business.
Because of the liability risk, partnerships usually have trouble bringing in investors.
Another few forms of partnerships are the limited partnership or limited liability partnership, which allows the limited partners to control how much they are liable for the business' debts. In such structures, there are limited partners and at least one general partner.
The general partner will be the business's day-to-day manager and will have total liability for the business debts in proportion to their ownership. Limited partners, on the other hand, will not run the business on a day-to-day basis and will only risk their personal investment in the partnership. Limited partners will still receive a proportionate share of the business' profits and losses.
Limited partnerships are more attractive to investors because their liability will be limited. The limited liability prevents the partnership's debts from affecting the investor's personal assets. By the same token, limited partnership interests are protected if an investor is sued personally.
Limited partnerships also have the tax benefits of regular partnerships. The profits and losses will be put on the partner's' individual taxes rather than in the business.
Limited partnerships also keep the benefit of allowing general partners to come together to pool their money and skills. However, just like a general partnership, the partners will be fully liable for debts of the partnership.
Limited partnerships will require more complex filing requirements than normal partnerships. Furthermore, the limited partners are barred from participating in management. If they are running the business, they lose their liability protection.
Limited Liability Partnership (LLP)
Limited liability partnerships are another organizational business structure if all the owners want to protect themselves against liability.
- In an LLP, the partners will all get limited liability as well as regular partnership benefits, such as pass-through taxes and the ability to decide how the LLP is managed.
- Compared to general partnerships, LLP partners are able to actively manage the partnership without being held personally liable for the company's debts.
- LLPs are restricted by law. They are only allowed to be formed for certain kinds of businesses, such as for lawyers or doctors.
- LLP partners will still be responsible for their personal mishaps as well as certain kinds of debts, depending on the situation.
However, the LLP partner will not be required to be liable for the debts of other partners.
The Pros of Partnership
A partnership is a simple business structure that's easy to maintain. Very little paperwork is required. However, some municipalities and states do have requirements, so you should check your state's statute to make sure your business is compliant.
Creating a company involves many difficult decisions, including which business structure to use. Partnerships offer a lot of benefits. However, no matter the structure, you will need to be familiar with the particular demands and characteristics of your business.
Partnerships also have some problems, however. When deciding which business form to use, you will need to think about the kind of business you will be running and how a partnership would fit into that business. Partnerships particularly become very complex when there are many partners and investors involved.
Despite the drawbacks of partnerships, they still have many beneficial aspects. The biggest benefit of a partnership is that it allows people to pool together their skills and money to start a business. Businesses are expensive ventures, and the partnership model allows people to combine capital to create their company.
If a company follows regulations from the start, it has a higher chance of succeeding in the future. It is important to have a good business plan, good partners, and to make sure your business is properly registered.
In a partnership, the decision-making process is relatively smooth and easy compared to corporations. Furthermore, partnerships face low filing and regulatory requirements.
Partnerships allow many people who trust one another to brainstorm ideas and combine their talents and skills. If some owners want to participate more than others, there are partnership structure variants that can be useful. Partners can be divided up by their knowledge or function, or some other means, to play to everyone's strengths.
When partnerships have investors, however, it can raise questions about how to motivate all the partners to participate to the best of their ability. Partners need to be incentivized to contribute their skills and knowledge to the company. Such motivation is usually provided through profit-sharing.
Partnerships offer many benefits for companies. In particular, the partnership model is more helpful than a sole proprietorship because each partner brings with them connections and funds that become part of the company's resources.
The Cons of a Partnership
Partnerships nonetheless have many drawbacks. For example, partners are still liable for the profits of the business and will have to report the partnership's income on their tax return. Profits and losses are a part of each partner's personal responsibility.
Furthermore, in most of the partnership models, the partners will have unlimited personal liability for the company's debts.
Partnerships can also easily collapse. If a general partnership has no provision regarding what happens if a partner leaves or passes away, then the partnership would collapse should this occur. Even though partnerships are easy to form, it is helpful to have more formal documents and procedures to ensure the business will run smoothly. Having an agreement on file is also important if partners end up having disagreements.
Because partners are each personally liable for the company's obligations, the business partners need to be selected carefully, and the duties and the rights of each partner must be clearly defined.
Partnerships allow decision-making to be smooth and avoid complicated bureaucracy when all the partners agree. However, if the partners disagree, decisions may become difficult to make. If partners have very different visions for the business, these differences could go unresolved.
Partners will have to decide among themselves what skills and how much money each of them will provide for the partnership. This should be set out in the original partnership agreement. It is important to set out what each partner's duties are, because since each partner shares in the partnership's profits equally, the partnership may face trouble if some partners are doing less than others.
Funding and Managing a Partnership
Having at least two individuals who contribute funds is a notable benefit of a partnership. The more capital you invest at the outset, the better your chances of having a successful business that is able to expand and grow. You'll be able to create profits that will be divided among the contributors.
Partnerships are subject to a few laws and regulations that dictate their managerial structure, which allows the partners to create a flexible arrangement that plays to everyone's strengths.
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