Thinking of starting a business with one or more associates? Consider officially establishing a partnership.
Simply put, a business partnership is a legal relationship between two or more individuals working together to progress mutual interests.
Each member contributes an investment of some form (money, property, labor, skills, contacts, etc.) and shares in the profits and losses of the business. Unlike other business structures, forming a partnership does not involve the establishment of an entity that is legally separate from the founders.
Selecting the wrong business model can have negative legal, structural, and operational implications for your business, so make sure you choose the structure most suitable for you.
Before you and your partners sign the dotted line on your partnership agreement, it’s important that you first understand the advantages and disadvantages of a partnership.
10 Advantages of a Partnership
Forming a partnership presents unique advantages that can affect every aspect of your business — from finances and taxes to work-life balance and productivity.
1. Not Subject to Income Taxes
Although partnerships must file information with the IRS about their annual financial performance (revenue, profits, losses, gains, etc.), they don’t have to pay income tax directly.
Instead, a partnership “passes through” any profits — or losses — to the partners. In turn, all partners must include their share of profits or losses incurred by the business on their personal tax returns.
2. Access to Complementary Skills and Knowledge
A partnership can provide you access to important skills and experience — especially in areas you’re lacking. Most successful partnerships work well because partners have complementary skill sets, and help each other fill gaps in expertise.
For example, you may be experienced in sales and business development, whereas your partner might be a certified accountant.
3. The Division of Overhead and Other Costs
Overhead expenses are among the biggest challenges of building a new business. Sharing startup costs and other expenses is an attractive aspect of a partnership.
4. Increased Opportunities for Productivity and Expansion
Not only can a partner help you shoulder the workload and other responsibilities of a new business, but they can also connect you to other business professionals and help you grow your business in ways you never imagined yourself.
5. Better Work-Life Balance
With a partner, there is less pressure on you to handle every detail of your business. In this way, having a partner can improve your work–life balance — which studies have shown leads to increased productivity.
If an associate is interested in leaving the partnership, they can use an assignment of partnership interests to transfer the right to receive benefits to a new partner.
6. A Second Perspective
One of the major advantages of a partnership is having someone on your level with a different perspective, who can provide valuable input when making important decisions.
7. Fewer Formalities and Obligations
Unlike limited liability companies and corporations, partnerships don’t need to be registered with the Secretary of State. Most states legally recognize partnerships once they begin business operations.
8. Easy to Convert to Other Business Structures
If you decide that you need more protection for your business later on, converting your partnership to an LLC is simple. To begin the process, you just need to submit official conversion documents to the Secretary of State’s Office.
9. Ownership and Control in Equal Measure
While the operator of a limited company or corporation might be subject to the demands of shareholders or a board of directors, a business partnership involves more freedom. Members answer only to each another, and don’t need to worry about external decision-makers.
10. Privacy and Confidentiality
Partnerships aren’t required to publicly disclose their financial and organizational information. Companies and corporations, on the other hand, must make this information available to the IRS and shareholders.
For example, a publicly-traded company must distribute an annual report to their shareholders and post it on their company website for the public to view.
7 Disadvantages of a Partnership
While partnerships enjoy certain freedoms, there are disadvantages as well. The disadvantages of a partnership highlight why selecting a trustworthy partner is vital.
1. Increased Liability
One of the major disadvantages of a general partnership is the equal liability of each partner for losses and debts.
Each partner has unlimited personal liability, which means you are responsible for any bad business dealings your partner enters into. Every decision your partner makes carries potential consequences for your personal assets and finances.
For example, if the business has been unprofitable and you can’t make payments on a loan your partner took out, creditors might sue you and take your personal assets such as bank accounts, cars, and houses.
2. Less Autonomy
Partners have equal decision-making power (unless otherwise specified in an amendment to the partnership agreement. Decisions must be made jointly, which means you will sometimes have to compromise.
3. Potential for Partner-Partner Conflict
Partnerships, like most relationships, can quickly become complicated when associates disagree. This is especially true if there are only two partners, and there is no one to break the tie in a disagreement. It’s important to outline how disagreements will be solved in your partnership agreement.
4. Complications with Future Sale
When forming a partnership business, work an exit strategy into the documentation. Issues can arise when one partner wants to sell and the other doesn’t.
5. Decrease in Stability
Partnerships offer a high degree of freedom, but this contrasts with the stability an incorporated organization provides. Given that the business relies entirely on the partners, life situations such as a death, birth, illness, and other unexpected events may substantially affect the company’s functioning.
6. Perceived Lack of Prestige
For many, a limited liability structure is a sign of prestige. While some informality can be attractive for those involved in the organization, it can worry investors looking to put money in or otherwise collaborate with the business.
7. Shared Profits
Partners must share profits in the same way they share labor and overhead expenses. While a partner means more opportunity to generate increased revenue, it also means that revenue must be shared according to the terms of the agreement.
Do the Benefits of a Partnership Outweigh the Disadvantages?
Deciding whether to move forward with a partnership can be challenging. There are some distinct advantages — freedom and flexibility being chief among them.
On the other hand, choosing a limited company or corporation business structure can help you avoid the associated disadvantages.
Now that you know the pros and cons, you and your associates can select the right business structure to meet your business goals — by building a partnership agreement or otherwise.