Partnership is a type of business in which two or more persons mutualy own and operate the business and agree to share profits equally or according to profit sharing ratio. It is similar to sole proprietorship in many ways. There are two main sub-classifications of partnerships:
A partnership in which all the partners share in gains or losses, and all have unlimited liability for all partnership debts, not just some particular share. For example if A and B setup a partnership, they share profits and losses equally. The partnership defaults on a loan of $200,000. Only $100,000 is recoverable from the partnership assets. The remaining $100,000 will recovered from A & B $50,000 each if both can pay, but if say A is not able to pay anything, the entire $100,000 can be recovered from the personal assets of B.
In which there are one or more general partners and one or more limited partners. General partners run the business and have unlimited liability, but limited partners although owners do not actively participate in the business. The general partner's liability is unlimited just like the owner of a sole proprietorship, but a limited partner's liability for business debts is limited to the amount that partner contributes to the partnership which means that nothing will be recovered from a limited partner's personal assets. This form of organization is common in real estate ventures, public accounting, etc.
Advantages and Disadvantages
The advantages and disadvantages of a partnership are basically the same as those of a proprietorship. But in some instances, there are some differences outlined below:
- The partnership terminates when any of the general partners sells its assets. A new partnership is formed if the other partnership accepts the purchaser of such share as a partner.
- All income is taxed as personal income to the partners as in sole proprietorship.
- More capital can be raised due to involvement of more individuals.
- Ownership of a general partnership is not easily transferred, because a transfer requires that a new partnership be formed. However, a limited partner may sell his share without dissolving the partnership.
- In case of general partnership a written agreement called partnership agreement is required.
Written by Obaidullah Jan, ACA, CFA and last modified on