What is a partnership?
A partnership is a business organisation established by two or more individuals for the purpose of making a profit. The owners are called partners. A partnership is usually the form of business founded by individuals who intend to pool their resources together and share the responsibilities of running the business, e.g., consultancy or professional services.
Partnership deed
A partnership deed or deed of partnership is an optional document drawn up by the partners to minimise disagreements. In contrast to incorporated entities, forming a partnership does not require any stringent formalities. However, partners should prepare a legally binding agreement on vital issues that could abruptly lead to the end of the business. Some of the aspects to be specified in the partnership deed are profit or loss sharing ratio, duties and responsibilities of partners, capital to be contributed by each partner, partners’ salaries, and how to admit a new partner.
Every country has a law governing partnerships that can be applied when there is disagreement among partners who have not prepared a partnership deed, for example, the Partnership Act of 1890 (UK).
General partnership versus limited partnership
A general partnership is a type of partnership in which all partners are liable for the debts of the business. In other words, each partner has unlimited liability. If the partnership is unable to pay its debts (insolvent) and the business’s assets are insufficient to settle the creditors, the partners’ personal assets will be sold. All general partners are actively involved in running the business unless the partnership deed or agreement states otherwise. In addition, a partner’s action is binding on other partners except there is a contrary provision in the partnership agreement.
While a limited partnership provides for the existence of limited partners who have limited liability, there must be at least one general partner who is liable for the partnership’s debts. Limited partners only risk their capital in the business to meet the obligations of the partnership, not their personal assets. Although the limited partner shares in the profits, he is not actively involved in the management of the business. The rights of the limited partner are stipulated in the limited partnership deed or agreement.
Advantages of a partnership
Specialisation in management
The fact that more than one individual come together to form the business makes diverse skills available. Partners can focus on their areas of expertise for better management and organisational performance.
Relatively easy to establish
A partnership requires fewer formalities than a company. Therefore, it can be easily established as paperwork or regulatory requirements are minimal. There is no need for a memorandum of association and articles of association, which are legally required documents for the formation of a company
More capital for expansion
A partnership has more capital than a sole trader because it is financed by multiple individuals. Therefore, more money is available for expansion.
Sharing of losses
Unlike a sole trader, losses are shared by the partners. It ensures that one person is not overburdened if the business incurs a loss. The profit or loss is split as agreed upon by the partners.
Privacy
A partnership is not mandated to make its affairs public. The accounts of the business are not required to be published, thereby ensuring its strategies remain confidential.
Better decisions
Every partner contributes ideas before decisions are made. Decisions are better because there are inputs from different individuals. The success of the business does not depend on a single individual.
Disadvantages of a partnership
Unlimited liability
Partners are personally liable for the business’s debts if it cannot pay them. However, some countries permit the establishment of a limited partnership. A limited partnership has both general and limited partners. There must be at least one general partner who has unlimited liability. The limited partners have limited liability because they are not personally liable for the debts of the partnership.
No separate legal existence
A partnership, like a sole trader, is an unincorporated entity. Consequently, the partners have no separate legal existence from the partnership business. It is the partners who are sued if the business is sued.
Sharing of profit
The profits do not belong to one individual because the business is co-owned. Profits are shared among the partners in accordance with the pre-agreed sharing ratio.
Lacks continuity
A partnership business comes to an end following the death of a partner or at the end of a specified term. Thus, it has a shorter lifespan than a company which is expected to exist perpetually.
Inadequate capital
The capital contributed by the partners is usually inadequate. It cannot raise additional capital by selling shares like a company.
A partner is liable for the mistakes of others
The partners are bound by the decision made by any of them. A partner can take actions or sign contracts on behalf of other partners. If mistakes are made, all the partners are liable.