A partnership is an unincorporated association of two or more individuals to carry on a business for profit. Many small businesses, including retail, service, and professional practitioners, are organized as partnerships.
Characteristics of a Partnership
A partnership agreement may be oral or written. However, to avoid misunderstandings, the partnership agreement should be in writing. The agreement should identify the partners; their respective business‐related duties and responsibilities; how income will be shared; the criteria for additional investments and withdrawals; and the guidelines for adding partners, the withdrawal of a partner, and liquidation of the partnership. For income tax purposes, the partnership files an information return only. Each partner shares in the net income or loss of the partnership and includes this amount on his/her own tax return.
The life of a partnership may be established as a certain number of years by the agreement. If no such agreement is made, the death, inability to carry out specific responsibilities, bankruptcy, or the desire of a partner to withdraw automatically terminates the partnership. Every time a partner withdraws or is added, a new partnership agreement is required if the business will continue to operate as a partnership. With proper provisions, the partnership's business may continue and the termination or withdrawal of the partnership will be a documentation issue that does not impact ongoing operations of the partnership.
In a partnership, the partners are agents for the partnership. As such, one partner may legally bind the partnership to a contract or agreement that appears to be in line with the partnership's operations. As most partnerships create unlimited liability for its partners, it is important to know something about potential partners before beginning a partnership. Although partners may limit a partner's ability to enter into contracts on the company's behalf, this limit only applies if the third party entering into the contract is aware of the limitation. It is the partners' responsibility to notify third parties that a particular partner is limited in his or her ability to enter into contracts.
Partners may be called on to use their personal assets to satisfy partnership debts when the partnership cannot meet its obligations. If one partner does not have sufficient assets to meet his/her share of the partnership's debt, the other partners can be held individually liable by the creditor requiring payment. A partnership in which all partners are individually liable is called a general partnership. A limited partnership has two classes of partners and is often used when investors will not be actively involved in the business and do not want to risk their personal assets. A limited partnership must include at least one general partner who maintains unlimited liability. The liability of other partners is limited to the amount of their investments. Therefore, they are called limited partners. A limited partnership usually has LLP in its name.
Ease of formation
Other than registration of the business, a partnership has few requirements to be formed.
Transfer of ownership
Although it is relatively easy to dissolve a partnership, the transfer of ownership, whether to a new or existing partner, requires approval of the remaining partners.
Management structure and operations
In most partnerships, the partners are involved in operating the business. Their regular involvement makes critical decisions easier as formal meetings are not required to get approval before action can be taken. If the partners agree on a change in strategy or structure, or approve a purchase of needed equipment, no additional approvals are needed.
Relative Lack of regulation
Most governmental regulations and reporting requirements are written for corporations. Although the number of sole proprietors and partnerships exceeds the number of corporations, the level of sales and profits generated by corporations are much greater.
Number of partners
The informality of decision making in a partnership tends to work well with a small number of partners. Having a large number of partners, particularly if all are involved in operating the business, can make decisions much more difficult.