In business, a partnership is an arrangement where two or more persons share the profits according to agreements. Partners are collectively co-owners of the enterprise and also contribute to the capital of the business.
Partners also share the management responsibilities of the firm. A partnership is essentially an agreement to advance the mutual interest of the partners. Partners in the agreement could involve businesses, Governments, individuals, schools, or a combination of any of these.
Partnership laws in each jurisdiction govern the rules, regulations, and obligations of the partnership firms. Partners not only share profits but losses and liabilities as well.
Partnership structure was designed to spur growth in small businesses. Unlike limited companies, a partnership structure tends to have lesser obligations like simpler accounting standards.
In most jurisdictions, partnerships attract different tax structures, and the entity is not taxed, instead the income of partners is taxed. Companies are incorporated under company laws and have a plethora of obligations, but partnerships come with relatively lesser obligations.
In a sole proprietorship, capital is employed by a single person, who has all the obligations for the liabilities and is the owner of all assets.
Conversely, a partnership enables sharing capital deployment, asset, liabilities, losses, and profits. Partnership structure allows sharing roles and responsibilities in the business enterprise.
With many partners in a firm, it allows broadening the capability of the management decision and outcomes. Partnership firms also onboard new partners based on their needs. For instance, a law partnership could invite a new partner, who specialises in a practice lacking at the firm.
Partners in a firm are invested in the business through the capital. Losses and profits are also shared on a share in the firm, which is usually based on the proportion of capital invested in the business.
It also motivates the partners to remain committed to the firm since losses and profits would be shared as well.
A partnership firm has no independent legal existence unless the agreement has a specific provision in place. When the partners of the firms leave or cease to be partners anymore, the firm is dissolved. In this way, the firms could be unstable and uncertain.
Since partnership firms are not taxed separately and the profits are shared by the partners that are taxed at individual income tax level, partners cannot retain the earnings.
Partnership firms do not provide tax planning opportunities compared to limited companies. Thus, making it tax inefficient for the partners.
Even if one partner has made significantly more efforts compared to other partners, the profits would be shared as per the partnership agreement. Profit and loss sharing could be good, but it may well turn out to be disastrous as well.
More number of partners in a firm increases the chances of higher level of disagreements among them. Since decisions are also bound to be consulted with each partner, the decision-making ability of the firm could be hampered in the event of disagreements among partners.
General Partnerships are the most common partnership firms that exist in many jurisdictions. Small businesses often incorporate a General Partnership since it is the simplest partnership, which requires minimal formalities.
Share of profits could be enlisted in the partnership agreement and is usually based on a similar proportion of the capital invested by the partners. At least one partner in GP has unlimited liabilities since a partnership is not a separate legal entity.
In this way, partners will be held accountable if the firm enters bankruptcy and dues are supposed to be cleared by the partners.
Limited Partnerships allow one to have limited partners in the firm. LPs can have a mix of general partners and limited partners. It is incorporated to designate limited partners with specific responsibilities without bearing any significant liability.
It can be the case that limited partners are not involved in the daily operations of the business and contribute on a consulting basis. Limited partners usually invest capital in the business and take a share of profit. They largely remain out of the decision-making roles.
Limited Liability Partnerships are a more complex type of partnerships. The structure allows partners to have limited liabilities along with limited scope on managerial decisions. These limits are often defined by the extent of a partner’s investment in the firm.