Business Partnership: Definition, Types, Pros, and Cons

What Is a Partnership?

A partnership is a formal agreement between two or more parties to run and operate a business and share its profits.

A partnership is an arrangement in which parties known as business partners agree to work together to advance their mutual interests. Partners in a partnership can be individuals, businesses, interest-based organizations, schools, governments, or combinations.

Organizations can form partnerships to increase the likelihood that each will accomplish their mission and to expand their reach. A partnership can lead to the issuance and holding of equity capital or it can only be regulated by contract.

There are different types of partnership agreements. In particular, in a partnership business, all partners share the liabilities and profit equally, while other partners may have limited liability. There is also the so-called “silent partner” in which one party is not involved in day-to-day business.

How Does a Partnership Work?

A partnership is a legal relationship that usually comes about through a written agreement between two or more people or companies. The partners invest their money in the business, and each partner benefits from all profits and bears a portion of the losses.

The partnership as a business often has to register with all countries in which it does business. Each state can have different types of partnerships that you can form. Therefore it is important to know the possibilities before registering.

Some partnerships include individuals who work in the business, while other partnerships may include partners who have limited ownership and also have limited liability for the business’s debts and any lawsuits filed against it

In contrast to a corporation, a partnership is not a unit that is separate from its individual owners. A partnership is comparable to a sole proprietorship or independent contractor business, as the business is not separate from the owners for liability reasons for both types of business.

Income tax is not paid by the partnership itself. After profits or losses have been shared among the partners, each partner pays income tax in their individual tax return.

Partnership

Types of partnerships

These are the four types of partnerships.

1. General partnership

A general partnership is the simplest form of partnership. It is not necessary to form a business entity with the state. In most cases, partners start their business by signing a partnership agreement.

Ownership and profit are usually divided equally between the partners, although they can set different terms in the partnership agreement.

In a general partnership, all partners have the independent authority to bind the business to contracts and loans. Each partner is also fully liable, They are personally responsible for all debts and legal obligations of the business.

That’s a lot of power and a lot of mutual responsibility. Suppose a general partnership has three partners. One of the partners takes out a loan that the business cannot repay. All partners can now be personally liable for the debts.

General partnerships are easy to set up and dissolve. In most cases, when one partner dies or goes bankrupt, the partnership automatically ends.

2. Limited partnership

Limited Partnerships (LPs) are formal, government-authorized companies. You have at least one general partner who has full responsibility for the business and one or more limited partners who provide money but do not actively run the business.

Limited partners invest in the business for financial returns and are not responsible for its debts and liabilities.

Through this silent partner limited liability, the limited partners can participate in the profits, but not lose more than they have invested. In some states, limited partners may not qualify for pass-through taxation.

If you begin to actively run the business, you may lose your limited partner status and protection.

Some LPs appoint a Limited Liability Company (LLC) as a general partner so that no one has unlimited personal liability for the business. This option may not be available in all states and is much more complicated than an LP.

3. Limited liability partnership

A limited partnership (LLP) works as a general partnership with all partners actively running the business but limiting their liability for each other’s actions.

The partners remain fully responsible for the debts and legal liabilities of the business, but they are not responsible for errors or omissions of their fellow partners.

LLPs are not licensed in all states and are often limited to specific professions such as doctors, lawyers, and accountants.

4. Limited liability limited partnership

A Limited Liability Limited Partnership (LLLP) is a newer type of partnership available in some states. It works like an LP, with at least one general partner running the business, but the LLLP limits the general partner’s liability so that all partners have liability protection.

LLLPs are currently licensed in Alabama, Arizona, Arkansas, Colorado, Delaware, Florida, Georgia, Hawaii, Idaho, Illinois, Iowa, Kentucky, Maryland, Minnesota, Missouri, Montana, Nevada, North Carolina, North Dakota, Oklahoma, Pennsylvania, South Dakota, Texas, Virginia, Washington, and Wyoming.

California does not approve LLLPs, but does recognize LLLPs formed in other states.

Because they are not recognized in all states, LLLPs are not a good choice if your business operates in multiple states. In addition, their liability protection has not been thoroughly examined in court.

Characteristics of Partnership

  • Limited life. The lifetime of a partnership can be fixed for a certain number of years by the agreement. If such an agreement is not made, the partnership automatically ends due to death, inability to perform certain tasks, bankruptcy or a partner’s desire to withdraw. Every time a partner leaves or joins, a new partnership agreement is required if the business is to continue as a partnership. With proper provisions, the business of the partnership can continue and the termination or withdrawal of the partnership is a documentation problem that does not affect the ongoing operations of the partnership.
  • Mutual agency. In a partnership, the partners are agents of the partnership. As such, a partner can legally bind the partnership to a contract or arrangement that appears to be consistent with the partnership’s business. Since most partnerships have unlimited liability for their partners, it is important to know about potential partners before starting a partnership. Although partners can limit a partner’s ability to enter into contracts on behalf of the business, that limit only applies if the contracting third party is aware of the limitation. It is the responsibility of the partners to point out to third parties that a particular partner is restricted in their contractual capacity.
  • Unlimited liability. The partners can be asked to use their personal assets to pay off business debts if the business is unable to meet its obligations. If a partner does not have sufficient assets to pay his share of the business ‘s debts, the other partners can be held individually liable by the paying creditor.
  • Ease of formation. Apart from registering the business, a partnership only has to meet a few requirements.
  • Transfer of ownership. Although the dissolution of a partnership is relatively easy, the transfer of ownership, be it to a new or existing partner, requires the consent of the remaining partners.
  • Management structure and operations. In most partnerships, the partners are involved in the running of the business. Their regular participation makes critical decision-making easier as no formal meetings are required to obtain approval before action can be taken. If partners agree to change strategy or structure, or approve the purchase of the required equipment, no additional approvals are required.
  • Relative Lack of regulation. Most government regulations and reporting requirements are written for businesses. Although the number of sole proprietorships and partnerships exceeds the number of corporations, the sales and profits generated by corporations are far higher.
  • Number of partners. The informality of decision making in a partnership tends to work well with a small number of partners. Having a large number of partners, especially when everyone is involved in the operation of the business, can make decisions much more difficult.

Forming a Partnership

Partnerships are usually registered with the state or states in which they do business, but the registration requirements and the types of partnerships available vary from state to state.

Partnerships use a partnership contract to clarify the relationship between the partners; what contributions, including cash, will be made to the partnership the roles and responsibilities of the partners; and the distributing share of each partner in profits and losses. This agreement often only exists between the partners; it is generally not registered with any state.

Check with your state’s secretary of state to find out the requirements for registering your partnership in your state. Some states allow different types of partnerships and partners within those partnerships.

Creating a Partnership Agreement

A strong partnership agreement regulates the distribution of decision-making powers and the settlement of disputes. It should answer all “what-if” questions about what happens in a number of typical situations.

For example, it should spell out what happens when a partner wants to leave the partnership. State law applies if the articles of association do not regulate how to deal with the separation or other issues that may arise.

A partnership agreement is best created with the help of an experienced attorney.

Joining an Existing Partnership

An individual can join a partnership at the beginning or after the partnership has existed. The incoming partner must invest in the partnership, bring capital (usually money) into the business, and create a capital account.

The amount of investment and other factors, such as the amount of liability the partner is willing to assume, determine the new partner’s investment and share of the business’s profits (and losses) each year.

How Partners Are Paid?

Partners are owners, not employees, so they generally do not receive a regular paycheck. Each partner receives a distributed share of the business’s profits and losses every year. Payments are made on the basis of the articles of association and are taxed individually by the partners.

Each partner can draw funds from the partnership up to the amount of the partner’s equity at any time. A partner can also withdraw funds from a partnership through guaranteed payments. These are payments that are similar to a salary paid for service to the partnership.

In addition, some partners may receive a guaranteed payment that is not tied to their partnership share. This payment is usually used for services such as administrative tasks.

How Partners Pay Income Tax?

The partnership income tax is passed on to the partners and the partnership files an information declaration (Form 1065) with the IRS. Individual partners pay income tax on their share of the profit or loss of the partnership. The partners receive appendix K-1, which shows their tax liability towards the company for the year. Appendix K-1 is included together with the partner’s other income in his personal tax return (Form 1040 or Form 1040-SR).

Advantages and Disadvantages of Partnership

Consider a partnership if the number of people involved is small (up to about 20) and limited liability is not necessary.

Advantages of a partnership include that:

  • Two heads (or more) are better than one
  • Your business is easy to set up and the cost of setting up is low
  • More capital is available for the business
  • You have greater credit capacity
  • Top-class employees can be made partners
  • There is the possibility of dividing your income, an advantage of particular importance due to the resulting tax savings
  • The partners’ business affairs are private
  • There is limited external regulation
  • It’s easy to change your legal structure later if circumstances change.

Disadvantages of a partnership include that:

  • The partners liability for the business ‘s debts is unlimited
  • Each partner is “jointly and severally” liable for the business ‘s debts; that is, each partner is liable for his share of the partnership debts as well as for all debts
  • There is a risk of disagreement and friction between partners and management
  • Each partner is the authorized representative of the partnership and is liable for the actions of other partners
  • As partners join or leave, you will likely need to evaluate all of the partnership’s assets and this can be costly.

FAQs.

What Is a Partnership?

A partnership is a formal arrangement by two or more parties to manage and operate a business and share its profits. There are several types of partnership arrangements. In particular, in a partnership business, all partners share liabilities and profits equally, while in others, partners may have limited liability. There also is the so-called “silent partner,” in which one party is not involved in the day-to-day operations of the business.

What Is a Business Partnership?

A business partnership is a way of organizing a company that is owned and sometimes run by two or more people or entities. The partners share in the profits or losses.

What is the definition of Partnership?

A partnership is a for-profit business organization comprised of two or more persons. Each partner shares directly in the organization’s profits and shares control of the business operation. The consequence of this profit sharing is that partners are jointly and severally liable for the partnership’s debts.

What are the 4 types of partnership?

These are the four types of partnerships.
1. General partnership.
2. Limited partnership.
3. Limited liability partnership.
4. Limited liability limited partnership.

What are the advantages of a partnership?

A partnership may offer many benefits for your particular business.
1. Bridging the Gap in Expertise and Knowledge.
2. More Cash.
3. Cost Savings.
4. More Business Opportunities.
5. Better Work/Life Balance.
6. Moral Support.
7. New Perspective.
8. Potential Tax Benefits.

What are the Disadvantages of a partnership?

Disadvantages of a Partnership:
1. Liabilities.
2. Loss of Autonomy.
3. Emotional Issues.
4. Future Selling Complications.
5. Lack of Stability.