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
Pros and Cons of a Partnership
There are many pros and cons of a partnership. Partnerships are a legal structure for a business in which partners report the profits and losses of the business on their own tax returns while also remaining liable for the partnership’s liabilities. It is a flexible structure with many benefits and drawbacks.
What Is a Partnership?
Partnerships are a kind of company with a least two persons, the partners. The partners provide capital and work to the partnership and in exchange receive a share of the partnership’s profits and losses.
The partnership form is a legal structure with specific benefits and drawbacks. You should be aware of what is best for your business before forming it as a partnership.
To start off with, you should create a partnership agreement between you and the other partners. Even though the law doesn’t require it, this agreement will set certain ground rules for how the partnership will operate and will be very useful.
The 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 also are more long-lived usually 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, as well as be good communicators, and also bring skills and ideas to the company that you may not have. Communications 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, such as through investigations or discussions. Furthermore, remember that partnering with someone in business is very different from simply enjoying their presence socially.
Because a partnership is easier to form than to break, be very careful with whom you 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 need to collect together the capital, manpower, and skills to do so. Many business owners who want to bring together people of different skillsets 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 conflict over how much each partner is working for the partnership and what they are doing. Partnerships may 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 distinct features. It is quite easy doing pass-through taxes. You just put all the income and expenses on your personal tax return instead of the one of the business.
Partnerships are also simple and flexible, as well as being less costly and complicated to create than other forms such as limited partnerships or corporations.
In terms of organization, partnerships have the freedom to be centralized or decentralized.
A major benefit of partnerships is that it allows people of different backgrounds to pool together their skills and money in 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 have trouble usually in 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 day-to-day manager but also have total liability for the business debts, in proportion to their ownership. Limited partners, in contrast, will not run the business on a day-to-day basis but only risk their personal investment in the partnership, rather than being on the hook for more liability. Limited partners will still receive a proportionate share of the business’ profits and losses.
Limited partnerships are useful because they are able to better attract investors, who find limited partnerships more appealing because of their limited liability for investors. The limited liability prevents the partnership’s debts from affecting the investor’s personal assets.
Furthermore, limited partnership interests are in fact protected from being taken if the investor is personally sued in some cases.
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 a LLP, the partners will all get limited liability as well as regular partnership benefits, such as pass-through taxes and choosing how the LLP is managed.
- Compared to general partnerships, LLP partners are able to both actively manage the partnership while still not being personally liable for the company’s debts.
- LLPs are restricted by law. They are only allowed to be formed in certain kinds of business sectors, such as for lawyers or doctors. This makes LLPs very restricted unless you are in certain sectors.
- 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
Partnerships are overall a straightforward structure that is simple to make, keep, and used. The filing requirements are small, often not even needing formal paperwork or filings with the government. Some municipalities and states do have requirements, and it is beneficial to see what you need to do to be in compliance.
Creating a company requires many difficult decisions, including what form to use. Partnerships are a very beneficial form. However, no matter the structure, you will need to be familiar with the particular demands and characteristics of the business you are operating in.
Partnerships also have some problems. When deciding what business form to use, you will need to think about the kind of business you will be running and how a partnership would fit on 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 get the money together to create their company.
If a company gets off the ground well, it has a higher chance of succeeding in the future. It is important to have a good business plan, good partners, and make sure your business is properly registered and started in order to create a profitable venture.
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 by function, or some other means to play to everyone’s strengths.
When partnerships have investors, 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 really be contributing their skills and knowledge to the company, usually through profit-sharing. Partners need to believe in the company, as that is the point of the partnership.
Partnerships overall have many benefits for companies. The partnership model also is helpful compared to a sole proprietorship because each partner has a network that is then also a part of the company’s resources.
The Cons of 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, then the partnership collapses if any partner leaves or dies. 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 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 with care, and the duties and rights of each partner also clearly defined.
Partnerships allow decision-making to be smooth and avoid complicated bureaucracy when all the partners agree. However, if partners disagree, decisions may become difficult to make. If partners have very different visions of what the partnership will do, these differences may be unable to be resolved.
Partners will have to decide amongst themselves what skills and how much money each of them is providing 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.
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