A partnership is an agreement in which two or more persons combine their resources in a business organization with a view to making a profit. Partners share in the profits according to the terms of the agreement.
In a General Partnership, two or more owners share the management of a business, and each is personally liable for all the decisions, obligations and debts of the business. This means that each partner is responsible for, and must assume the consequences of, the actions of another partner or other partners.
A second type of partnership is a Limited Partnership which involves limited partners who combine only capital. They are not involved in managing the business and cannot be liable for more than the amount of capital they have contributed. A limited partnership also involves general partners, who are involved in management. They are fully liable for the debts and obligations of the business, but may be entitled to a greater share of the profits.
Let’s take a look at advantages and disadvantages of partnerships.
Advantages of partnership
Advantages of partnerships include:
1. Easy and cheap to set up. The partners sign a legal agreement which sets out the rights and obligations of each partner. It is called the Deed of Partnership and is written up in order to establish the terms of the partnership and to protect all partners in the event of a disagreement or dissolution of a partnership. Similar to sole traders, there are very limited laws and regulations affecting partnerships, so it is quite straightforward to set up.
2. Financial strength. More partners to invest in the business means more access to capital. Therefore, partnerships usually have greater access to finance than sole traders as there is more than one person to invest capital in the business. Hence, additional sources of investment capital for growth injected by each partner. It is also easier to secure external sources of finance in partnerships due to the lower risks. Additionally, partnerships can also attract investment from ‘sleeping partners‘ (people who invest in the business but take no active role in the running of the organization).
3. Cost-effective thanks to specialization and division of labor. Partnerships are more cost-effective than sole traders because each partner specializes in a certain aspect of the business, thus raising productivity and average cost, e.g. different doctors specialize in different areas of medicine, or the partnership has several lawyers where each of them is being in charge of different area of law such as corporate law, criminal law, immigration law or divorce law. It makes the partnership to benefit from shared expertise, shared workload and moral support. With more specializations, its client base will most likely to be much larger. Also, partners may specialize in different areas of business management therefore benefit from broader management base.
4. Shared decision-making. Decision-making is shared between the partners and often leads to better long-term decisions thanks to mutual trust. There is less workload and stress as the management and day-to-day running of the business is also shared which reduces the managerial workload for each individual owner.
5. Sharing losses. Business losses are shared among all the partners. Therefore, each partner faces less financial risk, so liability and risk of failure is shared.
Despite of its popularity around the world, running a business organization as a partnership also has several disadvantages.
Disadvantages of partnership
Disadvantages of partnerships include:
1. Unlimited liability. All partners, with the exception of ‘sleeping partners’, are jointly liable for the partnership’s debts, meaning that the partners have unlimited liability for all the debts of the business. They will have to use their personal wealth to pay these debts (if the partnership is not able to do so).
2. Sharing profits. The partners must share all the profits between themselves. Because a partnership has more than one owner, therefore profits are usually shared out between the different partners.
3. Difficult to raise finance. Despite having more access to capital than a sole trader, partnerships still find it difficult to raise large amounts of money. It is because partnerships are often fairly small businesses and like sole traders find it difficult to raise additional finance to expand the business. It is not possible for a partnership to raise capital from selling shares.
4. A lack of continuity. If one of the partners leaves, retires or passes away, then the business ceases to exist and will need to be reformed in case the other partners want to continue trading. As with sole traders, there is no continuity and the partnership will have to be reorganized.
5. Prolonged decision-making. Decision-making takes longer as there are more owners involved than just a single sole trader who makes all of the decisions by himself or herself. Disagreements and conflicts also occur quite frequently. A sole trader, taking on partners, will lose independence of decision-making therefore decision-making becomes diluted. Conflict of interest is present as partners may have disagreements over important business decisions.
6. Lack of harmony. It is difficult to find suitable partners. It causes disagreements and conflicts within partnerships to be quite a common phenomenon. Each partner is legally and financially dependable on others, so a mistake made by one person can negatively impact all the other partners. Business decisions are binding on all partners, even if they do not agree with them, so possible development of conflict between partners.
