What are 3 advantages and 3 disadvantages of a partnership?

A partnership is a form of business organization in which owners have unlimited personal liability for the actions of the business. The owners of a partnership have invested their own funds and time in the business, and share proportionally in any profits earned by it. There may also be limited partners in the business, who contribute funds but do not take part in day-to-day operations. A limited partner is only liable for the amount of funds he or she invested in the business; once those funds are paid out, the limited partner has no additional liability in relation to the activities of the partnership. If there are limited partners, there must also be a designated general partner that is an active manager of the business; this individual has essentially the same liabilities as a sole proprietor.

Advantages of a Partnership

The key advantages of a partnership are noted below.

Source of Capital

With many partners, a business has a much richer source of capital than would be the case for a sole proprietorship.

Specialization

If there is more than one general partner, it is possible for multiple people with diverse skill sets to run a business, which can enhance its overall performance. In general, this may mean that there is more expertise within the business.

Minimal Tax Filings

The Form 1065 that a partnership must file is not a complicated tax filing.

No Double Taxation

There is no double taxation, as can be the case in a corporation. Instead, profits flow straight to the owners.

Disadvantages of a Partnership

The disadvantages of a partnership are noted below.

Unlimited Liability

The general partners have unlimited personal liability for the obligations of the partnership, as was the case with a sole proprietorship. This is a joint and several liability, which means that creditors can pursue a single general partner for the obligations of the entire business.

Self-Employment Taxes

A partner’s share of the ordinary income reported on a Schedule K-1 is subject to the self-employment tax. This is a 15.3% tax (social security and Medicare) on all profits generated by the business that are not exempt from these taxes.

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A partnership is a business entity in which two or more people or businesses work together as one company or business. You may feel that a partnership is the right direction for your company because it offers better resources for your own business to flourish. Learning about the advantages and disadvantages of a partnership is an important first step in determining whether a partnership is the right direction for you. This guide will outline those pros and cons.

Advantages of a Partnership

Here are some potential advantages for you to consider when thinking about starting a partnership. One or more of these may be relevant to you and help your business thrive.

More Time at Home

Having a partner means that you are not doing all the work alone. This means that you can reduce the number of hours spent on the job because you know that the work is getting done. Partnerships can allow you to create a better work-life balance.

New Perspectives and Varied Expertise

Partnering with someone means you gain their experience, expertise and knowledge. A good partnership will help two parties bridge the gaps that exist in their solo operations. Look for a partner who offers a different perspective than what you currently have to be able to tackle problems in a new way.

Support When You Need It

Having a partner means that you have someone on your team with you. This person can be a great source of strength and an outlet for venting on bad days, and also gives you someone to share in successes with. Knowing that you’re in it together can also ease the stress one feels when starting a business.

Varied Cash Flow

Depending on the partner, you may be able to get more cash to fund the business. Some partners may have access to capital resources that you do not and are able to help fund the operations better. This is important as many companies fail because they don’t have strong financial resources to maintain operations and grow.

Sharing Expenses

Partners are able to share the expenses, which means that you won’t bear the costs all on your own. It takes money to run a business, and a partner helps meet those cost demands. Sharing capital expenditures is a great advantage of a partnership and allows both parties to keep more of their personal funds

Pass-Through Taxation

Partnerships themselves are not taxed as entities; they pass through the taxes to the partners. This means that your revenues are taxed at your personal income tax rate. You avoid the double taxation that happens if you own a corporation, where the company pays tax and then you pay tax on your dividends. Partnerships operating an LLC may be eligible for other tax benefits as well.

Increased Availability To Pursue Opportunities

When working on your own, you have to choose where to place your time and energy. This means that you might not be able to pursue all the business opportunities that arise. But when duties are shared among partners, there is a better ability to increase productivity and pursue new opportunities.

Disadvantages of a Partnership

As with any major business decision, it is important to weigh the disadvantages of a partnership agreement. While there are many advantages, you need to be prepared for the downside.

Personality Conflicts

Partners don’t always agree, and personalities don’t always align. Choose a partner carefully to avoid negative personality conflicts. However, even in choosing the best partner possible, you can’t predict how a person will react to certain stresses. This can lead to personality conflicts and emotional issues working with the partner.

You’re Both on the Hook for Liabilities

Just as partners share in the revenues and profits of a company, they also share in the liabilities. If your partner increases liabilities to grow the business, this also impacts you. If you don’t want to add more liabilities to your bottom line, you should agree to discuss financial decisions together before acting. You also are legally liable for mistakes or errors your partner makes when representing the business.

Lack of Autonomy

When you remain solo, you maintain 100% control over the business and all decisions that are made. Once a partner enters the picture, decisions are shared, and you lose autonomy. This might not be a big deal if both partners are on the same page for growth, but it can be a problem if partners have different visions for the future of the business.

Selling Can Be Challenging

If you plan on selling the business in the future, you may have a more difficult time doing so with a partner on board. If your partner doesn’t want to sell, this could mean that you are stuck in the business longer than you wanted to be and need to work out an arrangement with the partner to be bought out. All partnership agreements should have a “right of first refusal” that requires the partners to offer their ownership share to the other partner before they can sell it to a third party.

Sharing the Profits

We’ve mentioned that having a partner means you aren’t on the hook for funding the business on your own, but the flip side of that is that you also have to split the profits. During periods of lackluster performance that could mean you both walk away with very little—or in periods of high growth, there may be arguments of how to divvy up the proceeds. Try to have agreements in place early on to avoid this point of contention.

Is a Partnership Right for Your Needs?

Once you’ve weighed the advantages and disadvantages of a partnership, it’s time to decide on what to do. If growing your business is the goal and you have certain skill gaps that a partner can fill, a partnership makes a lot of sense. But if you feel a specific partner may be more of a headache than an asset, you may want to wait and look for someone who better aligns with your business goals. Learn more in our full guide to partnership agreements.

Bottom Line

Getting a partner can be the answer that your business is looking for. It can provide a whole host of advantages that include more skills, opportunities and cash flow. But don’t choose just any partner. You also want one who aligns with your goals of selling the business, is compatible with your personality and is easy to work with.

Frequently Asked Questions

What are the different types of partnerships?

There is a general partnership (GP), limited partnership (LP) and limited liability partnership (LLP). A limited partnership has general partners and limited partners. The limited partners are only liable up to their investment in the partnership while the general partners have extensive liability. In a limited liability partnership, all of the partners are limited partners. Limited liability limited partnerships (LLLP) also exist, but are less common.

Which type of partnership is best?

A general partnership is a basic partnership that is simple to create and does not require separate filings with the state. Discuss options with your partner and legal counsel to find the best fit for your unique needs.