Starting a business comes with many different important considerations and decisions to make. One of the most important decisions when thinking about the structure of your business is whether to go it alone or include some like-minded investors to work with. If you are considering working with others, a partnership is one of the business structure options you have.
What Is A Partnership?
As you consider pooling resources with others to start a business, you need to know exactly what a partnership entails. Generally speaking, a partnership is a business where two or more individuals contribute equally. Their contributions come in terms of capital investment, property, skills and expertise, labor, and other assets. The partners share equally in the profits and losses made by the business. Decisions in a partnership are made through consultation.
Most partnerships involve individuals with different assets, skills, and schedules and thus it may not seem fair to divide profits and losses equally. This makes it necessary to draft up a formal partnership agreement. This document offers agreements and guidelines on important issues such as the distribution of profits and losses, the decision-making process, management roles, each partner’s roles, conflict resolution processes, and procedures to be followed when changing ownership, adding partners, withdrawal of partners from the business, or removal of partners. Though such an agreement may not be legally binding, it may form part of evidence in case of disputes and it is considered exceedingly risky to start a partnership without one.
Types of Partnerships
Partnerships come in many different forms which can generally be categorized into three main types.
This is the most basic and most common type of partnership for small business startups. In this type of business structure, it is typically assumed that the partners share profits and losses on an equal basis. They share all other benefits, liabilities, responsibilities, and managerial duties equally. However, the partners can enter into a form an agreement stipulating a more equitable distribution as they see fit. In their partnership agreement, they need to define each partner’s level of liability, percentage of profit and loss due, extent of managerial responsibility, and how much money each invests in the business.
This is a slightly more complex arrangement compared to a general partnership. It is a partnership with limited liability in that partners may bear liability limited only to the extent of their investment and can also have limited input in the running and management of the business. Limited partnerships are highly favored by investors looking for short term projects that have high yield. They are also favored by investors who have the money but lack the expertise.
A joint venture is very similar to a general partnership. The difference lies in the fact that joint ventures are set up for a specified limited duration or to accomplish a particular project. Once the project is accomplished the partnership automatically stands dissolved or the partners can make further arrangements to continue working together. However, if they make the decision to continue operations after accomplishing the initial goal, they will need to file as an ongoing partnership.
Taxation for Partnerships
Whatever country you are operating from, you will most likely be required by law to register your business, obtain licenses and permits, and obtain a tax identity for the business entity. Depending on the laws of your country or state, you will need to file annual information returns with the tax agency reporting the business income, gains, losses, expenses, and deductions. However, in most countries partnerships do not pay taxes as an entity. The taxes are passed through to the individual partners who file their earnings from the business together with their usual personal tax filings. The kinds of taxes the business and the partners need to be aware of include:
- Self-employment taxes
- Personal income tax
- Annual return of income
- Employment tax
- Excise taxes
Advantages of Partnerships
There are many advantages that come with working together with like-minded people to run a successful business in a partnership structure. These include:
Partnerships are fairly inexpensive to form. The permits and licenses requirements are usually few and low-priced in most jurisdictions.
Easy To Establish
As mentioned, the legal requirements for registration, or obtaining permits and licenses is fairly easy and inexpensive. Apart from a few key industries, you will rarely find high legal restrictions on formation of partnerships.
Shared Financial Load
Coming up with business funds is so much easier when you have partners. The fact that you can pool resources together is also beneficial in terms of getting extra financing from banking institutions and securing credit.
It is very rare to find one individual with all the skills necessary for running a particular business. For instance, a dentist may be good at his core job but may be lousy at marketing his services or keeping the financial records. Partnerships have the advantage of pooling different skill sets from the different individuals.
If a partnership gets lucky enough to retain some highly skilled staff, they have the option of including a partnership deal to incentivize that staff member. This greatly improves work output as employees strive to do their best in order to one day become part owners of the business.
Disadvantages of partnerships
Silver linings do have dark clouds and thus there are a few drawbacks in structuring a business as a partnership. These include:
All the partners in a business are liable for each other’s decisions and mistakes. All partners are liable for all debts, losses, actions, and decisions made by any of the partners. Additionally, they all bear collective responsibility even for actions they neither approved of nor had knowledge of. General partnerships are even worse in this aspect as all the partners bear unlimited liability and this puts their personal assets at risk.
Partnerships require that all decisions be made after consultation and agreement by all partners. However, this is not always possible. Most partnerships may adopt simple conflict resolution mechanisms such as democratic voting. However, these may erase the trust and goodwill of members who happen to always be voted down. The good thing is that partnerships are usually formed on a platform of goodwill and mutual trust. Therefore, it is much easier to find amicable solutions based on consensus and compromise.
Inequitable Profit Sharing
All partners share the successes, victories, and monetary gains of the business. This is regardless of each partner’s level of input and at times this result in unfair sharing. For instance, the partner who wakes up daily to perform the daily tasks, oversee employees, find clients, and produce work may feel unappreciated if s/he has to share profits with the partner who reports once a week and lazily sits around.
A partnership is one of the best business structures for a small enterprise. However, one must weigh all the pros and cons before picking on the ideal structure. Of special importance is consideration for the taxation structure you will want to adopt for your business.