When launching a new business, choosing the proper legal structure is one of the most important decisions you will make. While partnerships can offer opportunities for entrepreneurs to join forces with like-minded individuals and get a business off the ground, it is important to understand the pros and cons of a partnership, as compared to other business structures. Partnerships come with several risks, and what works for one business may not be right for you.
The Essential Elements of a Partnership
A partnership is a relationship between two or more people to conduct trade or business. Each partner contributes money, property, labor, or skill, and shares in the profits and losses of the business. A partnership is very similar to a sole proprietorship, with the exception that it has more than one owner (partners).
A partnership is considered a “pass-through” entity, which means that each co-owner pays taxes on their shares of the business income using their personal tax returns. While a partnership must still file an annual tax return to report the income, deductions, gains, losses, etc., from its operations, the entity is not responsible for paying income tax at the business level.
In a general partnership (GP), each partner is personally liable for all of the business debts and claims, not just their share. Limited partnerships (LP) offer some additional protection in that only the general partner is liable for partnership obligations. Limited partners, who invest in the business but take no part in its operation, are shielded from such liability. A limited liability partnership (LLP) operates much like a GP; however, the partners have limited personal liability for any wrongful or negligent acts involving others.
Breaking Down the Pros and Cons of a Partnership
Before launching a new venture, it is important to consider all the partnership pros and cons. Partnerships are one of the simplest business forms to operate with more than one person. As compared to a sole proprietorship, a partnership allows for multiple people to contribute to the success of the business by contributing funds and labor. Partners can also share in the decision-making and rely on each other’s expertise.
Another key advantage of a partnership is that it is easy to establish and costs less to set up as compared to other business entities. It is also fairly simple to change your legal structure as your business grows. Partnerships are also subject to far less regulation as compared to corporations and even LLCs. There are also no corporate formalities to observe, such as conducting regular meetings or filing annual reports.
The major disadvantage is that general partners have unlimited liability, meaning that each partner is personally liable for all of the business debts and claims, not just their share. Should your business fail or face a costly lawsuit, creditors may even seize your personal property to recover outstanding partnership debts.
Partnerships are also prone to disputes, which can put a significant strain on your business and your finances. Partnership disagreements often involve communication breakdowns and differing expectations of the time, money, or effort to be contributed by the partners. Also, because the actions of one partner can directly impact the others, disputes often occur when one partner takes action without the approval of the others, such as executing a long-term lease without conferring with the other partners.
Many of the risks of a business partnership can be reduced through a comprehensive partnership agreement. For instance, partners should have a written agreement that clearly outlines key issues, such as the financial contributions and duties of all partners, the distribution of profits and losses, and the procedures for resolving disputes. Partnership agreements should also include an exit strategy, such as procedures for one partner to buy out the interest of another or dissolving the partnership.
Pros and Cons of a Partnership: The Importance of Selecting the Right Structure for Your Business
Every startup should carefully consider what entity type best fits your needs and business goals. As small businesses grow, they should also periodically evaluate if their current structure is still the best fit. In either case, there are a number of factors to consider, including personal liability for business owners, tax treatment, and administrative burdens and expenses.
To make a fully informed decision, business owners should work with an experienced counsel to discuss all the pros and cons of a partnership, LLC, or corporation. At Scarinci Hollenbeck, our business attorneys work with small businesses across New Jersey and the New York metropolitan area. With years of experience advising small businesses, we understand that every business is unique and work tirelessly to develop a legal strategy that meets your goals and your budget.
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