Partnership

Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

Partnership Meaning

A partnership is created when two or more people come together intending to operate a business and decide to share the profits, risks, and liabilities. It exists even if the parties involved don’t have a written contract and might not even be aware that they’ve created a partnership.

What is Partnership ?

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This form of business can bring in more resources and funds than other modes of doing business, such as sole proprietorship. In addition, it provides the benefit of starting a for-profit organization with more than one person involved, where there is minimum risk and better resource management.

Key Takeaways

  • Partnerships are business agreements when two or more persons or organizations come together for a common cause, usually profit-making. There are two types of – Limited and Limited liability.
  • The formal agreement should describe the partners’ responsibilities, rights, and tasks. It can clear capital interests, profit distribution, and business continuity in case of a partner’s departure.
  • One of the most significant advantages of partnerships is that they are easy to form, and there is a need for only little to minimum compliance after incorporation.

Partnership Explained

A partnership is a mode of business where two or more people join forces to start a profitable venture and do not choose any other type of business organization. A for-profit company organization’s default structure is termed a general partnership. Here involved parties share liabilities equally because they are simple to form, and the organization is not taxed as a corporate entity. As a result, it can conduct business more informally than corporations. 

Partnerships have always been famous commercial structures due to their many advantages. A partnership agreement is a base that establishes the partnership.

A partnership entity is distinct from its partners. Based on the agreement, it is either limited liability or unlimited liability. Liability is the obligation borne by a partner to take part in the risk or debt associated with the transactions. Partners have to pay out of their pockets in case any debt arises.

Since the organization is formed with the motive of earning profits, it is the income that is taxed. Therefore, each partner has to pay their share of profits worth taxes. Businesses with several owners, professional organizations (like law firms), and those looking to test out a potential business idea before forming a more formal company may find that partnerships are a useful option.

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Types

Limited liability partnerships (LLPs) and limited partnerships (LP) are the two types of business partnerships:

All partners in limited partnerships have limited liability except for the one general partner with unlimited liability. The agreement states that the limited liability partners often have little authority over the business. As a result, profits are passed through to individual tax returns. And the general partner, or partner without limited responsibility, has to pay the self-employment taxes.

Similarly, limited liability partnerships allow each owner to have only a small amount of liability. Each partner in an LLP gets protection from claims against the partnership. They also do not hold liability for the activities of the other partners.

A public-private partnership is not a type but a different concept that works based on partnership. It is a long-term agreement between a government and organizations from the business sector.

Partnership Agreement

Various powers are provided in the agreement for a person to dissociate as a partner. The agreement generally governs the following things:

  1. The relationship between the partners and between the partners and the organization.
  2. The business, its operations, and how the partners should conduct them.
  3. The terms and conditions and means of amending the agreement.
  4. We are limiting the duties and rights of partners.

The agreement, however, shall not include provisions for the following:

  1. Exempting someone from the accountability of actions, including bad faith, intentional wrongdoing, or knowing violations of the law.
  2. I am unreasonably restricting the rights of partners. 

Examples

Check out these examples to get a better idea:

Example #1

Ariel, Ben, Cooper, and Daniel are friends; they want to start a clothing apparel business. The name is “ZZEUS clothing store.” So they pool an amount of $100000 for the same and agree. Each bought $25000 per person. Their agreement contains the business’s name and location and the partner’s contribution. In addition, it includes the purpose on which the business operations are based. The rights and liabilities of the partners are also present in the agreement.

Example #2

Sony, a major technology company, is a Japanese multinational conglomerate corporation. Hyundai is a famous, South Korean multinational automotive manufacturer. Both companies are joining as partners to launch high-tech battery-electric vehicles by 2025 to redefine mobility. They hope to lead the mobility evolution with this joint venture. Sony brings experience with sensors, computer chips, and digital displays to almost every vehicle today.

This puts them in a position to provide cutting-edge onboard infotainment systems and enhanced safety technology. However, if it tried to enter the automobile business independently, it would be behind in vehicle R&D and manufacturing capabilities, which could cost billions of dollars and take years to build. Honda can help with its extensive expertise in creating mobility and technology for manufacturing vehicle bodies. 

Advantages And Disadvantages

Partnerships offer many advantages for those involved as well as a few disadvantages. They are as follows:

Advantages

#1 Easy incorporation:

Most states in the U.S. have minimal or no laws and rules that dictate how a partnership should operate. As a result, the state’s business permits, licenses, and accounting requirements for partnerships vary depending on the business activity they engages in.

#2 Compliance:

A partnership hardly has any requirements to comply with after its incorporation. Its agreement sets all the regulations and governs them.

#3 Taxation:

Profits from partnerships under income pay the taxes and self-employment as the arrangement is an extension of partners.

#4 Resources:

Since multiple people participate in a partnership arrangement, gathering funds for business is relatively easy for the entity, unlike a sole proprietorship.

Disadvantages

#1 Liability

Since it is an arrangement between persons, partners are held liable for the partnership’s debts. If the entity gets sued, the partners can be held liable on behalf of the entity. Some states in the U.S., irrespective of whether it is a limited liability partnership, require at least one partner to be accountable.

#2 Limited growth:

The growth of a partnership happens only with the addition of new members to the arrangement. 

#3 Decision making

When multiple opinions are coming from different partners, reaching a consensus can be difficult and may sometimes lead to delays in decision-making.

Frequently Asked Questions(FAQs)

1. How is a partnership formed?

Partnerships are formed when two or more people or organizations agree, irrespective of whether the partners are aware of such an arrangement. The agreement comprises relevant details such as the profit, the nature of operations, partner details, their contribution, etc.

2. Do partnerships have limited liability?

The partners will bear limited liability if the agreement says it is a limited partnership. 

3. How are partnerships taxed?

The partners share the profit or loss from a partnership. They must file and pay taxes for their share of the profit. The ratio in which they share the profits follows the business partnership agreement. 

4. Why is a partnership the best form of business?

One of the significant reasons many consider it the best form of business is its easy formation. Even after formation, there are no strict compliances to be followed, making things more accessible and convenient.

This article has been a guide to Partnership and its meaning. Here, we explain its types, examples, and related agreement, with advantages and disadvantages. You can learn more about it from the following articles –

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