There are many ways to form a business, and each has its own distinct advantages and drawbacks. The four main types of business entities are partnership, sole proprietorship, corporation, and limited liability company (LLC).
A partnership business, by definition, consists of two or more people who combine resources to form a business and agree to share risks, profits, and losses. Common partnership business examples include law firms, physician groups, real estate investment firms, and accounting groups.
By comparison, a sole proprietorship places all the responsibilities, risks, and rewards of operating the business on one person, while a corporation operates as its own legal entity, separate from the individuals who own it. An LLC is a hybrid of a partnership and a corporation that allows its owners (known as members) to earn profits and losses without incurring personal liability for the company’s debts.
For many individuals, going into business with a partner offers a chance to build experience and expertise with others. This article takes a deep dive into partnerships, what they are, how they work, and how to manage them.
What Is a Business Partnership and How Does it Work?
A business partnership is an arrangement in which two or more individuals co-own a business entity and share in its profits and losses. This co-ownership is formalized through a partnership agreement that outlines roles, responsibilities, and profit-sharing structures.
Business partnerships can take several forms, each with unique characteristics:
- General partnerships (GPs): All partners are equally liable for the organization’s debts, obligations, and liabilities.
- Limited partnerships (LPs): Some partners have limited liability and restricted management roles, while others, known as general partners, assume full liability.
- Limited liability partnerships (LLPs): All partners can actively manage the business, with liability protections for all partners. Specifics vary by state, but partners in an LLP are typically not personally liable for business debts or the negligence of other partners.
- Limited liability limited partnerships (LLLPs): All partners have limited liability against partnership obligations, even those stemming from the actions of their co-partners. However, only general partners can actively manage the business.
Advantages and Disadvantages of a Partnership Business
Understanding the pros and cons of forming a partnership can help you decide whether it’s the most beneficial structure for your organization.
Advantages
- Stronger financial position: The ability to pool resources can provide your business with more capital and access to new investors, while better positioning the company to borrow money. Sharing business expenses with partners can also help you save more than you could on your own.
- Shared expertise: Sharing skills and institutional knowledge is a key benefit of a business partnership. This can help broaden your expertise and the versatility of your business.
- A broader network: By sharing contacts and connections with business partners, you can develop new relationships and expand your professional network.
- Fresh eyes: Bringing in partners can provide new perspectives on how you do business by seeing things from a different angle. Partners can offer fresh ideas, market strategies, and inspiration to grow your business.
Disadvantages
- Liability: The primary drawback of a general partnership is that all partners are fully liable for the financial obligations of the business and share losses, debt, and risk. This means creditors can seize any partner’s personal assets if these obligations aren’t met.
- Loss of full control: Unlike sole proprietors, who are used to complete decision-making autonomy, partners in a partnership must share decision-making authority and may need to compromise when there’s a disagreement.
- Potential for conflict: Having more than one person making business decisions creates the potential for differences of opinion that can lead to conflict. Partners may also become bitter if they feel like one person isn’t contributing his or her fair share.
- Difficult to sell: A partner can’t sell a business without the consent of all the other partners, unless stated otherwise in a partnership agreement. This could potentially create a stalemate if and when a partner wants to leave.
- Risk of instability: Without a comprehensive, predetermined partnership agreement in place, unexpected events, like a partner’s decision to leave, their death, or an illness may put the future of the company in jeopardy.
How to Create a Partnership Business
Working with one or more partners can add complexity to setting up a business. Adhering to certain steps can help simplify the process.
Select a partnership structure
To determine the ideal partnership structure, assess your liability preferences an desired management structure. Investment needs and future business goals can also dictate the best partnership choice. For instance, if you’re seeking significant external investment without giving investors a role in daily management, an LP might be ideal. Conversely, if you anticipate rapid growth and want to limit personal liabilities while maintaining managerial control, an LLP or LLLP could be a better fit.
State-specific laws can also affect partnership functions and rights, so that may be another consideration to keep in mind.
Choose partners and their roles
Find partners you trust, as this decision sets the tone and terms of your business. Decide how much it will cost to join the partnership, what percentage of the profits each partner will receive, and which roles and responsibilities each partner will have. Some partners may contribute equity or ownership share in the business, while others might be salaried partners who are paid as employees.
Name your business
Your partnership’s name is often a prospect’s first impression of your business. Consider a name that accurately represents the purpose of your partnership business or that incorporates the names of your partners as well as any designations, such as LLP or GP. Make sure to pick a unique name that isn’t already in use or trademarked to prevent legal complications.
Register your partnership
In the U.S., partnership businesses must register their names with the state in which they plan to operate. Additionally, registration might be necessary to obtain the appropriate business licenses or permits required by that state or local jurisdiction. Note that specific requirements can vary from state to state. Registration is typically required to open a business bank account, and will also help prevent inadvertently choosing the same name as an existing business.
Obtain a business identification number
In the U.S., business partnerships must obtain a business identification number from the Internal Revenue Service (IRS).
Create a partnership agreement
After you and your partners agree to their roles and responsibilities, get everything in writing. An attorney can help you draft a business partnership agreement to detail provisions, such as each partner’s rights and duties, financial obligations, profit distribution, ownership, dispute resolution, confidentiality, and exit strategy.
Secure necessary licenses and permits
To comply with federal, state, and local laws and regulations, partnerships may need specific permits or licenses to operate. For instance, the nature of the business activity and where it’s located can dictate state licensure requirements. Certain business activities may also require specialized licenses. For example, restaurants might need health permits, liquor licenses, or music licensing. Professional services – such as law, medicine, or accounting – often need professional licenses.
Bringing in partners can provide new perspectives on how you do business by seeing things from a different angle. Partners can offer fresh ideas, market strategies, and inspiration to grow your business.
The Business Partnership Agreement
A business partnership agreement is a written contract between partners that specifies their obligations and contributions to the business, as well as other conditions of their relationship. Every business partnership agreement should detail the following clauses:
- Who makes decisions: Determine how you will make important decisions and what to do when partners disagree or when there’s a tie.
- Percentage of ownership: It’s important to calculate and clarify how much of the business each partner owns. Also indicate how much money each partner contributed upon joining the business, and what should happen if the business needs more money to operate.
- Distribution of profits and losses: Set a formula for how partners will share earnings as well as losses. This might be based on ownership percentage, specific roles, or other criteria.
- Exit and transition strategies: Come up with contingency plans for what should happen if a partner dies, becomes disabled, or wants to leave the company. Specify the rights of the remaining partners in such situations.
Does a Partnership Business Make Sense for Your Company?
Before you decide whether a partnership is the ideal business type for your organization, consult with an outside expert to carefully consider the following:
- Legal liability: How much liability is ownership willing to assume? If you’re adequately insured and can afford to put your personal assets at risk, the financial opportunities of a partnership might be worth the risk.
- Long-term plans: Look ahead to what might happen to the business in the future. In a partnership business, it’s important to consider who will take over the business after the founding partners are no longer involved.
- Costs: Although corporations offer stronger liability protection compared to partnerships, they require more extensive record-keeping and reporting, thus incurring higher administrative costs than other business entities. They’re also the most expensive business type to form, making partnerships a more attractive option for many.
- Operational freedom: The business structure you choose can dictate how much flexibility, administrative responsibilities, and decision-making power you’ll have. Corporations tend to be the most restrictive in these areas. If you’re looking for more freedom, less bureaucracy and the authority to call the shots, a sole proprietorship might be the right choice for you. Partnerships fit somewhere in between, combining the benefits of autonomy and shared decision-making responsibilities.
The Bottom Line
Business partnerships have many advantages for someone looking to form a new company. Because they include several variations from which to choose, partnerships often combine the best attributes of other business types, offering flexibility around costs, liability, and autonomy. Selecting the right business type, however, often comes down to the unique circumstances of each business. Consider consulting legal and business experts to understand the implications of each business type, as well as the various federal and state requirements necessary to create them.
A version of this article was originally published January 15, 2020.
Photo: Getty Images
