Pros and Cons of Partnerships
They often say that two heads are better than one, but does it apply to businesses?
While this question can be easily answered with a YES or NO, things aren’t as simple as that.
And that’s why it’s better to discuss the pros and cons when a business has more than one owner.
In this article, we will be looking into the pros and cons of a type of business ownership that has more than one owner – Partnership.
What is a Partnership?
A Partnership is a type of business where there are at least two owners (formally called partners).
In a partnership, the partners have the shared responsibility to manage and operate the business.
Profits (and losses) will be shared depending on the partnership agreement (e.g. based on capital contribution, explicitly written on the agreement, etc.).
A business partnership may either be of the three types: general partnership, limited partnership, and limited liability partnership.
Each type has its benefits and drawbacks, but there are some that these three types of business partnerships have in common.
Pros of a Business Partnership
More people who manage the business
In a sole proprietorship, the sole owner has to manage all business operations on his/her own.
Customer relations, employee relations, business concerns- with all of these on your plate and then some, managing a business on your own can be very taxing.
With a partner, you can now share the ‘pains’ of managing a business.
Responsibilities can be divided or shared – you could be in charge of managing the employees, while your partner is in charge of managing supplier relationships.
Partnerships lessen the burden of each partner individually by sharing the responsibilities of managing a business.
Sharing of knowledge and expertise
Yes, the saying “two heads are better than one” can definitely be applied to business.
Unless you and your partrner/s are operating with one same mind, chances are, each of you has his/her treasure trove of knowledge and expertise waiting to be shared.
You and your partners could be from different industries, or maybe one of you has more experience in handling a business.
Maybe one partner is great at managing customer relations, while another could be an expert in accounting and bookkeeping.
Sharing each other’s knowledge and expertise may result in innovations and growth opportunities for your business.
More sources of capital
A business needs cash to keep itself running.
Having a partner means more sources of funding (besides creditors).
A partner can also bring assets other than cash into the partnership such as machinery, equipment, or even a building that can be used for business.
Capital contribution is one of the things that potential partners consider when entering into a partnership agreement.
With a partner, you might be able to pursue a business opportunity that you couldn’t on your own because of insufficient funds or lack of assets.
Sharing the cost of running a business
Having a partner means that you won’t be solely covering for the costs of running a business.
You and your partner/s will share the costs and operating expenses, resulting in you spending less individually.
It eases the financial burden of operating a business on you compared to when you’re doing it alone.
Opportunity to expand your business
Or maybe even pursue another business.
With a partner that can share their expertise, knowledge, and their cash, you may be able to expand your business – add more products or services, add a branch, cater to more clients, etc.
You may even be able to run another business concurrently.
Less paperwork compared to forming a corporation
The other common way to form a business with other people is forming a corporation, which entails a lot of paperwork.
You’d have to draft the articles of corporation, the by-laws, some other specific forms that the state requires…. forming a partnership is not like that.
A partnership can even be formed through verbal agreement, although having a written partnership agreement is always recommended.
As to forms and reports that the state requires of a partnership, the amount is minimal.
A partnership isn’t taxed on its own
Rather, any profits and losses are included in each owners’ individual tax forms.
This is unlike the taxation of corporations where the net income is taxed, and then the dividends received by shareholders are also taxed.
This means no double taxation for partners.
A partner can act as moral support
It can become lonely running a business on your own.
When things go sour, you may not have anyone to vent to.
When things went well, you may not have anyone to celebrate with.
A partner can offer more than just financial capital – a partner can be your emotional and moral support.
Surely you and your partner wouldn’t want your business to go south right?
As partners, you will want to help each other to make your business grow.
Cons of a business partnership
You cannot make business decisions on your own
Unlike in a sole proprietorship where you can make all decisions for your business, in a partnership, you need to have the consent of your partner/s.
In a partnership, you are no longer the sole owner of your business.
Your partner is your co-owner, and as such, they also have the right to matters regarding the business.
Any consequences that resulted from business decisions will be shouldered by all partners, be it made with or without consent from all partners after all.
Potential conflicts and disagreements
Just like relationships with other people, a business partnership isn’t immune from conflicts and disagreements.
There may come a time when you and your partner disagree on certain business decisions, which might halt the growth of your business.
Not to mention the emotional stress of being in conflict with each other.
When you’re planning to enter into a business partnership, treat it as if you’re entering into a relationship. Be sure that you can manage the stress that can come from conflict.
Sharing of profits
You share the costs of running a business, you also share the profits from such business.
Unless you’re earning more through the partnership as compared to running the business on your own, you might miss the feeling of raking all of the profit for yourself.
Of course, this wouldn’t be a problem if the partnership is earning lots.
But still, imagine if you were able to claim 100% of the profits huh?
The liabilities of the partnership are also your liabilities
That also includes the liabilities that your partner brought into the partnership.
In the case of the dissolution of the partnership, if the partnership’s assets are not enough to settle its liabilities, the creditors can go after your personal belongings.
If the partnership is being legally sued, then you are legally sued too even if it’s solely caused by the actions of another partner.
This might be the biggest downside to partnerships.
Complications in selling the business
Business partnerships are built on trust.
Should one of the partners decide to sell the business or sell their part of it, it may be hard to make the other partners agree.
The partners trust each other enough to form the partnership, so if one partner decides to transfer their rights to an outside party, that would be akin to starting a new relationship with a person that you don’t trust yet.
Most partnerships don’t even allow the automatic transfer of ownership to heirs in the case of a partner’s death.
Some partnerships address this issue by adding an exit strategy in their partnership agreement.
For example, it could be stated that the partners have the priority to purchase the interest of another partner who wants to sell his/her part of the business.
Individual tax as opposed to corporate tax
A partnership isn’t treated as a separate legal entity by the IRS. Instead, it is treated as a “pass-through entity” and does not pay any income taxes.
Rather, any profit that the partnership produces is included in each partner’s tax return and will be taxed at the individual rate.
This could be an issue because in general, individual tax rates are higher than business tax rates.
Types of Partnerships
Now that we’ve discussed the general pros and cons of a business partnership, let’s dig deeper into two of the three types of partnerships: limited partnership and limited liability partnership.
It’s important to know about these two types of partnerships because they are formed to specifically address some of the disadvantages of business partnerships.
In a limited partnership, there are two types of partners – the general partner, and the limited partner (also known as the silent investor).
A general partner is your typical partner, and as such, carries the pros and cons of a business partnership.
It is the inclusion of a limited partner that makes a limited partnership different from general partnerships.
A limited partner can only be liable up to the extent of what s/he invested in the partnership.
This is the main advantage of being a limited partner.
A limited partner can enjoy the profits without having to worry about losing more than what s/he invested.
However, unlike a general partner, a limited partner cannot actively manage the business.
Also, in some states, a limited partner cannot qualify for pass-through taxation.
A limited partner is also called a silent investor because s/he is only there to provide funding for the partnership in the hopes of gaining a share of the profits, and is not involved in the decision making and management of the business – like a typical investor.
And because of this, some of the benefits of a partnership can be lost.
For example, if there’s only one general partner, then that means that that general partner solely bears all the burden of managing the business, losing the benefit of sharing the responsibility of managing the business.
And if the only contribution of the limited partner is financial support, then the benefit of sharing knowledge and expertise can be lost.
Unlike a general partnership that can even be made with an oral agreement, a limited partnership must be formed with a formal written agreement and must be authorized by the state.
Not all states allow the formation of a limited partnership.
Limited Liability Partnerships
A limited liability partnership (LLP) is similar to a general partnership where all of the partners are responsible for managing the business, but there is one key difference – all partners have limited liability.
That means that the creditors of an LLP cannot go after the personal assets of a partner unless that partner is personally liable to the creditors.
Also, the partners are not responsible for another partner’s liabilities arising from errors, omissions, and malpractice.
The limited liability partnership is favorably structured towards professional groups such as doctors, accountants, and lawyers.
As professionals value their reputation, they don’t want it to be tainted due to the fault of another.
They don’t want to be responsible for another partner’s liability arising from negligence and malpractice.
Like a limited partnership, LLPs must be in writing and must be authorized by the state.
Some states only allow the formation of LLPS to certain professional groups while some don’t even allow the formation of LLPs at all.
FundsNet requires Contributors, Writers and Authors to use Primary Sources to source and cite their work. These Sources include White Papers, Government Information & Data, Original Reporting and Interviews from Industry Experts. Reputable Publishers are also sourced and cited where appropriate. Learn more about the standards we follow in producing Accurate, Unbiased and Researched Content in our editorial policy.