Pros and Cons of a Partnership | Considerations Before Starting

A partnership is a common form of business structure, defined in business law as an arrangement in which two or more individuals agree to operate a business together to make a profit. Each partner is a contributor of resources of some kind and, in return, shares the earnings that result from the enterprise.

Many entrepreneurs choose this formation route because it’s a practical way to combine skills and resources to provide a new business with a solid foundation. It can certainly present less of a burden in terms of finances and logistics than starting a company solo.

We’ve put together this article to take a closer look at partnerships, exploring the advantages and disadvantages involved. We’ve also taken a global perspective to ensure entrepreneurs can gain practical insights no matter where they are.

What Is a Partnership in Business?

Generally speaking, a partnership is a legal relationship formed between two or more individuals. Together, they enter into an agreement to operate a company, alongside sharing in its profits and liabilities. This approach is distinct from other business structures, such as corporations, that exist as separate legal entities from their owners, as partnerships are usually directly and legally tied to the individuals that form them.

There are also various types of partnerships, each serving different purposes. These include:

• General partnerships – In general partnerships (GPs), all partners have an equal share of management responsibilities, profit division, and liability exposure. This is the most basic type of partnership entrepreneurs can enter into.
• Limited partnerships – Limited partnerships (LPs) create a couple of different types of partners within the overall partnership. There are general partners who manage the business and assume liability. Alongside this, there are limited partners who will contribute capital to the organization, but have limited management control and limited liability exposure.
• Limited liability partnerships – Many jurisdictions also recognize limited liability partnerships (LLPs). These are structures in which partners are not typically liable in the event that the other partners act in a negligent way or demonstrate misconduct. This is a particularly common structure for law practices and accounting firms.

For the most part, partnerships are a widely recognized and common type of business structure across the globe. However, there are variations between jurisdictions in the rules that govern their formation and use.

Advantages of a Partnership

One of the reasons that partnerships are such a common type of structure globally is that they present a wide range of potential benefits for entrepreneurs. These include the following.

Shared resources and skills

This is among the most compelling reasons to form a partnership among most entrepreneurs. The structure provides opportunities to pool a diverse range of capital, knowledge, practical skills, and experience. As a result, there is often a stronger foundation to the business than sole proprietorships might achieve. Importantly, potential liabilities are spread among partners rather than being directed at a single individual.

Simplified formation

In many jurisdictions, partnerships are considered among the most simple business structures to form. Depending on the situation and location, formation of a partnership tends to involve little more than an agreement between the various parties involved. Some authorities require formal registration of certain types of partnerships, but this is often less complex than with other types of structure.

Direct control

One of the key advantages of forming a partnership is that owners retain a high degree of control over the business. With corporations and similar entities, owners are typically kept separate from managers, who exercise day-to-day control over operations and strategy. Partnerships usually grant all partners equal division of decision-making powers, enabling more active influence over the business’ success.

Tax benefits

Depending on the jurisdiction it is formed and operates in, partnerships can be the recipients of tax benefits. In some areas, partnerships are treated as pass-through entities, which means that all profits are only taxed once on the recipient owner’s personal income, rather than being subjected to corporate tax as well. Partnerships also tend to have less complex tax reporting obligations than other structures, which reduces the administrative burden.

Flexibility

Partnerships tend to have a greater degree of flexibility in various areas than corporations or limited liability companies (LLCs). For instance, partners can create their agreements in such a way that matches the needs of each partner and the roles they each plan to take. Partners can also choose to divide profits and responsibilities in a way that seems most fair to them. Importantly, these agreements can be adapted over time by agreement with all partners.

Disadvantages of a Partnership

As with many aspects of business, it’s important to understand that alongside the benefits of a partnership, there are also potential disadvantages. These include the following.

Unlimited liability

Particularly in the case of GP structures, each partner is personally liable for the company’s debts and other obligations. As a result, if the partnership finds itself in financial trouble or cannot fulfil its responsibilities, partners’ personal assets can be pursued by creditors. Except in the case of LLPs, even one other partner’s negligence can negatively impact the financial stability of all partners.

Conflict potential

At their core, partnerships are close collaborations. Sometimes, disagreements over strategy, operational elements, profit allocation, or even personality clashes can cause significant disruption. Unless clear communication and resolution processes are in place, these conflicts can prematurely end a business.

Profit sharing

In contrast to sole proprietorships—in which the single owner retains all profits—partnerships see profits being divided according to the mutual agreement. In many cases, simple equal sharing is effective. However, this can be complicated when some partners feel they’re contributing more than others and should therefore receive a greater distribution of profits.

Limited growth potential

Partnerships tend to find it more challenging to raise external funding than their corporation or LLC counterparts—even in the case of those asking can you start an LLC with bad credit. This means they’re usually reliant on the capital contributions of partners. When partners’ individual resources are limited, this can result in limited ability for the company to scale and develop.

Continuity issues

In certain jurisdictions, the partnership is considered to be dissolved automatically if one partner withdraws, is incapacitated, or dies. This means that continuity issues can arise at unexpected times. As a result, solid succession plans need to be put in place to manage such issues.

Key Considerations Before Forming a Partnership

Before taking the leap into a partnership, it is vital to ensure that there is an official written partnership agreement in place. In some instances, oral agreements can be considered technically sufficient; however, a formal and legally-binding document provides clarity and protection for everyone involved.

Additionally, it’s essential to take some time to assess the relationship between all partners. Entrepreneurs should examine how trustworthy other partners are, whether their personalities and skills are compatible, and if there are clear shared goals to aim toward.

Entrepreneurs should also take the time to research the legal and tax obligations for partnerships. These can vary depending on jurisdiction, which makes gaining guidance from strategic business formation consulting services experienced in global operations invaluable. 

Finally, engaging in succession or future exit planning from the outset of a partnership can mitigate unnecessary disruptions. This involves deciding how and when the business winds down and what contingencies need to be put in place to ensure continuity if something happens before that time.

Partnerships vs. Other Business Structures

Structure	Liability	Taxation	Governance
Partnerships	In most forms of partnership, the partners share full liability. In LLPs, partners are shielded from liabilities caused by another partner’s behavior.	Usually taxed as pass-through entities, meaning profits only get taxed once on owners’ individual income returns.	Flexible. Usually shared control and responsibilities, as set out by the partnership agreement.
Sole proprietorships	The single owner has full responsibility for all liabilities.	Profits taxed on the owner’s individual income tax return.	Has full control over all operations and strategies.
Corporations	As a corporation is a separate legal entity, owners’ personal assets are protected from business liabilities.	In many jurisdictions, there is double taxation of owner’s profits, first being subject to corporation tax, then income tax for individual owners.	Rigid and formal governance, with strategic control usually held by appointed managers rather than owners. Profit distribution is usually dictated by a shareholder agreement.

While partnerships can be useful tools, it’s also easy to see that they are subject to certain risks. After weighing these risks against the benefits, it is not uncommon for entrepreneurs to choose alternative structures that offer greater protections and access to resources.

FAQs

What are the pros and cons of partnership?

Partnership offer shared resources and some tax benefits, but there can be liability and conflict risks.

Is partnership better than a corporation?

It depends on the goals of the entrepreneurs involved. Partnerships are simpler, while corporations have stronger liability protections.

What is the biggest disadvantage of a partnership?

The most significant risk is usually exposure to personal liability for debts.

How can partners avoid disputes?

Clear written agreements that define roles, responsibilities, and profit sharing are essential tools here.

Can a partnership operate internationally?

Yes. However, the requirements and operating rules vary by country, making legal guidance essential.

References

Jarwal, D. (2020). Limited Liability Partnerships: A Business Model to Achieve Entrepreneurial Efficiency. ResearchGate. https://www.researchgate.net/publication/345241180_Limited_Liability_Partnerships_A_Business_Model_to_Achieve_Entrepreneurial_Efficiency 

Dar, A. (2022, May). Effect of Partnership on Business: A Case Study. ResearchGate. https://www.researchgate.net/publication/360754797_Effect_of_Partnership_on_Business_A_Case_Study