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Pros and Cons of Partnership Formation

Posted by Patrick Ivy | Jan 26, 2021 | 0 Comments

Forming a partnership can be one of the most simple and effective business entity choices, but it also has its drawbacks. Our experienced business lawyers at Newburn Law have worked with many clients to explain the pros and cons of partnership formation so they could make an informed decision about the best structure for their business. Contact us today if you are starting a business and considering forming a partnership. We pride ourselves on providing our clients with the information they need to make the best decisions for their unique businesses. Schedule a meeting with one of our experienced business attorneys at Newburn Law today.

What Is a Partnership?

A partnership is a simple business form where two or more people go into business together. Though most partners choose to enter into a written or verbal partnership agreement, a partnership can also happen by default when multiple “persons” enter into a profit-making activity together. The term person may mean an individual, but it can also be another business entity. For example, two corporations may form a partnership if they go into business together.

Pros of a Business Partnership

The following are some advantages of creating a business partnership.

Simplicity

Partnerships are extremely simple to form. Unlike a corporation or a limited liability company (LLC), partnerships do not need to file articles of incorporation or pay state fees to register the business. This may vary from state to state, so be sure to speak with an experienced business attorney to ensure you understand the business requirements of your state.

A partnership is generally formed as soon as two or more people decide to start a business. In fact, a partnership does not even require a formal agreement between the parties; a court may find that individuals became partners simply because they started doing business together.

Flexibility

Partners have total control of the management of the business, which allows them to make decisions more quickly and efficiently. Unlike in a corporation, which has hefty administrative requirements for decision-making, such as a mandatory annual meeting of shareholders to vote on important decisions, a partnership is limited only by the terms of its partnership agreement. A small business with two or three partners generally only requires the consensus of the partners to move forward on a business decision. Not all partnerships are this simple, however, and there are various types of partnerships that may affect each partner's rights and responsibilities.

Pass-Through Taxation

One criticism of corporations is that they face “double taxation” - they pay a corporate tax rate on the profits, and those profits are taxed again when the corporation pays dividends to shareholders. Partnerships, on the other hand, are usually taxed very simply. The partners divide their share of profits and losses, and the partnership is taxed on the partners' individual income tax returns.

Cons of a Business Partnership

There are also significant disadvantages when creating a business partnership.

Personal Liability

Corporations and LLCs offer the benefit of limited liability for their owners. General partnerships and sole proprietorships, however, do not limit the owners' liability for the business. When general partners go into business together, they are both personally liable for the business's debts, or in the event of a lawsuit, for any judgment against the business. This means that the personal assets of the general partners are at stake. Some variations of a partnership, such as a limited partnership or a limited liability partnership, may allow some of the partners to limit their liability to the amount of their investment in the business.

Dissolution and Dissociation

Although partnerships can be agile in their operations, they can also crumble if the partners do not agree on what happens if one of the partners leaves the partnership or dies. If the partnership agreement does not address what happens in this type of scenario, the state law will apply a default rule. In states that have adopted the Uniform Partnership Act, when one partner withdraws or dies, the partnership automatically dissolves. In states that have adopted the Revised Uniform Partnership Act, a partner dissociating does not automatically require the dissolution of the partnership, but the partner's share of the business must be assessed, and they must be paid out for their shares. In a corporation, buying and selling shares of a business is as simple as trading stock, so the dissolution or dissociation process of a partnership can be burdensome by comparison.

Unattractive to Investors

Because of the unlimited liability that comes with a partnership, as well as the burden of entering and exiting the partnership, it may be more difficult for a general partnership to raise capital than a corporation or LLC.

Types of Partnerships

Partnerships are not always as simple as two or three partners going into business together. There are multiple variations on a traditional partnership to allow for more flexibility depending on the needs of the business.

General Partnership

General partnerships are a simple form of business entity where all partners have unlimited liability for the debts of the company.

Limited Partnership

Limited partnerships, on the other hand, allow certain partners to limit their liability. In a limited partnership, there is at least one general partner who has unlimited liability for the business, while other partners, usually investors, enter the arrangement in a limited capacity. The limited partners are liable only up to the amount of their investment.

Limited Liability Partnerships

In a limited liability partnership (LLP), all partners have limited liability, but state law often limits LLPs to certain types of associations, such as law firms and accounting firms.

Our Business Lawyers Can Help You Understand Both the Pros and Cons of Partnership Formation

At Newburn Law, we have extensive experience forming businesses in many states and countries. We work closely with our clients to understand which type of business entity will fit their needs and objectives. Partnerships are often a great fit for small, lower-risk businesses that need the flexibility to make decisions quickly but careful consideration is essential to ensure the expected, and the unexpected, is accounted for. Contact Newburn Law to schedule a meeting with one of our experienced business lawyers today.

About the Author

Patrick Ivy

Patrick is a native of the Texas Hill Country. He attended The University of Texas at Austin, earning his undergraduate degree in finance in 2003 and his law degree in 2007. In the winter of 2010, he relocated to Denver, Colorado. He enjoys spending time with his family and alpine skiing.

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