A partnership is a specific kind of legal business relationship that you formed by an agreement with one or more other individuals. This structure allows you to operate a company as co-owners. Each partner in this relationship invests in the company, allowing everyone to share in the profits earned or the losses generated.
Business partnerships in the United States must register in every state where it does business. Each jurisdiction has several different kinds of structures that you can form using this option, so it is essential to know what the possibilities are before you complete your registration. Some partnerships include individuals who work in the company, while others offer partners that have limited participation or liability for debts or litigation.
Partnerships are not separate entities from their individual owners. It is a financial situation that is similar to that of a sole proprietor or independent contractor. The business isn’t separate from the owner for liability purposes.
If you have an idea to pursue with someone that you know, then the advantages and disadvantages of a partnership can help you to decide if this structure is the correct one to use.
List of the Advantages of a Partnership
1. Multiple types of partnerships exist.
Most states recognize three different partnership options: a general partnership, a limited partnership, or a limited liability partnership. The first choice is composed of partners who participate in the daily operations of the new company. Each one has liability for debt and lawsuits in their role, and there can be limited partners with the structure.
The second option has one general partner who manages the business operations of the new company. Then one or more limited partners invest in the agency, but they don’t participate in the operations and don’t have liability because of that fact. As for the final selection, it may have several general partners with a similar structure to that of the limited partnership. LLPs get formed when owners work in the same professional category, providing protection from liability from the actions of others.
2. You can have more help in managing business tasks.
Small business owners typically juggle many tasks because they wear multiple hats every day. Each owner is constantly surrounded by responsibilities that need completion. This work leads to late nights, long weekends, and problems that seem to constantly exist. If you have a business partner available, or multiple people, then you have extra help to complete these tasks.
Each partner can divide up the responsibilities of running the business based on individual strengths. Then each job gets completed faster, making it easier to tackle more problems together then if everyone tried to work alone.
3. Partnerships combine the wisdom, knowledge, and experience of each owner.
Each partner in this business structure can provide skills and knowledge that the business would not have if it operated as a sole proprietorship. Some people have a lot of experience managing the goods or services that an agency provides, but they don’t know how to correctly operate a company. Each partner can supplement the strengths of each other so that the business can progress forward in the correct direction.
This benefit allows each partner to tackle tasks based on their areas of specialty. Most partnerships like to have one person focus on big picture concepts while the other manages accounting or financial obligations.
4. You have fewer financial burdens with a correctly structured partnership.
It can get expensive to start a new business in today’s world. There could be costly overhead expenses for equipment, inventory, office space, and an e-commerce platform. Having a partnership can make it easier to manage these financial burdens. Instead of paying for everything yourself as you would in a single-member LLC or a sole proprietorship, you can split the costs with others.
This benefit makes it possible for the new company to potentially afford more items during its startup phase. It can also limit the initial debt amount that you can encounter at times when pursuing a new idea.
5. Partnerships come with less paperwork than other business structures.
Most states do not require you to file special paperwork to begin a partnership. The federal government in the United States treats this business structure as pass-through income, so it doesn’t require a significant amount of bureaucracy. The primary document that will govern this new opportunity is called a “partnership agreement.”
This agreement details the duties and responsibilities of each partner who forms the company. It should also outline how decisions get made, where profits and losses are divided, and other specific situations relayed it to your industry. The creation of this document is simple, especially when compared to the other bureaucratic needs of corporations or LLCs.
6. Fewer tax forms are necessary when you form a partnership.
There are no additional business entity taxes with a partnership, which means you don’t need to file a separate tax return for this business. The income passes through to each partner, which includes a personal share of the profits or losses. Then this figure goes on the individual returns, making everyone liable for paying their taxes based on the individual income levels involved.
7. You can upgrade your partnership at any time.
If you discover that a business partnership is not the correct structure for your company, then every state allows you to upgrade to an LLC or a corporation whenever you feel it is necessary. This benefit doesn’t require you to change your taxes if you take the default option for the limited liability company structure. It gives you a way to secure less personal liability while still enjoying the benefits of having co-owners that provide more strength to the corporate atmosphere.
8. Each decision gets to benefit from multiple layers of diversity.
Every business has big decisions that need to get made as time goes by. It can be easy to develop tunnel vision when you work by yourself because you become reliant on personal perspectives and opinions. That means important details can sometimes get overlooked. Having a business partner can help each person gain new perspectives on the choices to pursue. An additional set of eyes is a good thing when you can have constructed conversations in a safe environment.
9. Partnerships can create cost savings opportunities.
Having a business partner allows you to share the financial burdens for capital expenditures and expenses. This benefit enables you to manage the overhead costs more effectively than if you are flying solo. The result can be substantial savings, even if it does mean that you need to share the profits that the company earns each year.
10. More business opportunities can develop for partnerships.
When you have a partner available for a company, then you get to share the labor. That means your agency can become more productive while providing enough flexibility for each person to pursue additional business opportunities. This benefit can even eliminate some of the downsides that exist with the opportunity costs of a partnership.
That means everyone in this business relationship can create a better work-life balance. It gives each person a chance to take some time off when it is needed, knowing that there is someone to trust who can hold down the fort for you. It is one of the most positive impacts that occur when compared to a sole proprietorship or gig economy position.
11. Partnerships can provide much needed moral support.
Everyone needs a chance to bounce new ideas off of someone to generate some feedback. It is helpful to have someone available to debrief you on the important issues that happen in the business. These conversations can lead to high levels of moral support when setbacks occur in the partnership. It’s also an effective way to cope with the daily stresses that work provides, everyday frustrations, and the other challenging issues that all of us manage with the current state of the world.
12. You have ways to limit your liability with partnership structures.
Although this benefit doesn’t apply to every partnership structure, some states do allow for individuals to limit their liabilities with this business type. A limited partnership doesn’t allow you to participate in the management of the company, but you still get a chance to earn profits from the company’s activities. The limited role might not grant you the same level of earnings, but that’s a small trade-off for the reduced exposure that you receive. You’ll still get the advantages of pass-through tax treatment with this option, with the income allocated on the personal tax return.
You might also have the option to form a limited liability partnership, although this structure is available only for specific occupations. You’re still liable for any negligence of yourself or a direct employee who works for you with this structure.
List of the Disadvantages of a Partnership
1. You don’t usually get to make decisions by yourself in a partnership.
Unless your partnership agreement specifically states that you get to make decisions by yourself, this business structure requires the cooperation of each member. You must work with one another to make choices that benefit the company, even if that means all you do is run the information by everyone involved.
If a partner decides to act alone anyway and makes a reckless decision while doing so, then every person in the agreement is responsible for the results that happen. Unless there are specific stipulations in a governing agreement, the person who went rogue cannot be held solely responsible for the outcomes they produced.
2. Disagreements are going to happen in a business partnership.
When you have people who work together, then there is always the potential for conflict. You and your partners will not always agree on what the best course of action should be for your company. There can be times when you might even get sick of working in close proximity to each other. When these incidents occur, it is not always easy to dissolve the company you formed with everyone.
The easiest way to get around this disadvantage of a business partnership is to create an exit strategy as part of your initial documentation. You might need to redistribute profits, losses, and responsibilities, and the complete dissolution of the business might be necessary in some situations. Every jurisdiction is a little different, so you will need to check on the local rules while forming your new company.
3. A partnership forces you to split the profits.
If you operate a company by yourself, then you get to keep all of the profits that come from your hard work. When your business is a partnership, then you must share what you make with everyone else. You’ll still receive your fair share of the earnings, but a partnership with several members can mean that your cut gets somewhat small. That means you could be assuming a lot of risks if you’re not in an LLP without much to show for those efforts.
4. You get taxed individually when you work in a partnership.
Although some people will find this issue to be an advantage, it can also be a problem for some individuals. Business taxes generally have a lower rate than individual taxes, but because of the pass-through income that exists with the structure, you and your partners might pay more individually than if the company stood on its own as an “individual.”
Because of the pass-through nature of a partnership, each owner is responsible for the self-employment tax in the United States. That means you must pay the employee and employer share of Social Security and Medicare withholdings. That figure was 15.3% for the 2019 filing year, and it can take a significant chunk out of your earnings. There could also be state taxes that you must pay individually due to this structure.
5. It takes longer to make decisions in a partnership structure.
A sole proprietor, freelancer, or independent contractor can make instant decisions for their business or self-employment opportunity. Partnerships don’t have this luxury. When you need to run a decision by everyone involved in the work, then it can take longer to create the action you need for growth or progress. Waiting on approval could make it so that you miss opportunities because you weren’t able to respond quickly enough.
This disadvantage is similar to what LLCs and corporations face. The goal is to have enough experience in place where the diversity available can offset this issue, but that is not always the case.
6. Complications can arise if you want to sell the business in the future.
Sometimes circumstances change. You and your partners might be happy today with the state of the business, but tomorrow could be a different story. When someone wants to sell the company, this disadvantage can present difficulties for those who aren’t interested in that outcome. This issue is another reason why it is so important to have an exit strategy available from the first moment that you conduct commercial activities.
You might choose to include a right of first refusal if someone decides to sell their interest in the business to a third party. That means you retain the right to accept the offer instead of having a stranger join you in the company. It can also help with issues like an unexpected disability or a partner’s personal bankruptcy.
7. Partnerships come with a lot of unpredictability.
When you start to consider the advantages and disadvantages of a business partnership, then you must review whether you can cope with high levels of unpredictability. The changes that get triggered by a partner’s situation can cause significant instability in the business. If you thrive in this situation, then it won’t feel like a problem. If not, then you may need to seek out a different structure.
Having multiple partners will expand the issues that you encounter with this disadvantage. That’s why it is ultimately up to you to determine if you’re going to be comfortable managing this partnership role – or if you need to consider a different direction for your business idea.
8. Friendships don’t always outlast the breakup of a partnership.
If you think about what happens after the fallout of a divorce, how many couples actually remain friends? Although anything is possible, it doesn’t happen that often. Going into a partnership with a friend and expecting that friendship to remain if the business isn’t successful is an unreasonable expectation. It sounds like a great idea to do business with someone that you know and trust, but a career-first perspective always exists in the corporate world. That means you are risking a relationship at the same time you are putting your money on the line.
Starting a business can be one of the most empowering decisions that you can make for your career. It allows you to show off your expertise while establishing a stable income for yourself and others. This process can be a massive undertaking if you are doing all of the work by yourself, which is why it can be beneficial in some situations to take on a partner.
There is that old saying that says, “Two heads are better than one.” You might modify that for today’s world to say, “Three heads are better than two.” The companies that have access to high levels of diversity experience up to 40% better results than those who do not. That’s why a partnership can make sense.
The advantages and disadvantages of a partnership are essential to consider if you want to go into business with someone else. You’ll gain the benefits of pass-through income without the need to incorporate, but there are also some risks for you to consider. It may help to review these key points with your legal advisor to determine how you can protect your current assets effectively while still aiming for future profits.
Blog Post Author Credentials
Natalie Regoli, Esq. is the author of this post and the editor-in-chief of our blog. She received her B.A. in Economics from the University of Washington and her Masters in Law from The University of Texas School of Law. In addition to being a seasoned writer, Natalie has almost two decades of experience as a lawyer and banker. If you would like to contact Natalie, then go here to send her a message.