25th April 2023
25th April 2023
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5 - 1 vote
A partnership, is a type of business venture which is created by two or more persons come together to run a business for the purpose of carrying out a trade and making profit. The decision to form a partnership is usually attractive to entrepreneurs who do not want to run a business by themselves (i.e. as a sole trader). When a partnership is formed, it will run on the basis of a contract, which could either be written or oral.
In addition to this, a partnership does not require much formalities to be created. For this reason, a partnership may prove to be more attractive than forming a company which requires more formalities (e.g. registration with companies house, creation of a share structure etc). The lack of formalities needed to start a partnership does not restrict the size to which a partnership venture can grow. Similarly, even if a partnership begins through oral contract, the partners can decide to enact a written contract on which the partnership will function.
Where a partnership is formed via oral contract, it will be governed by the Partnership Act 1890. Additionally, if there is a written partnership contract, its provisions will override the provisions of the Partnership Act 1890 except where there are clauses on which the partnership contract is silent.
There are different types of partnership namely:
A partnership that starts as a general partnership can be changed into any of the two other kinds of partnership following the appropriate alterations to the structure of the partnership.
While a few can be inferred, a partnership is attractive to entrepreneurs because it offers the following benefits.
One of challenges of a sole trader business is the business owner has to operate the venture alone. While this has its uses, the presence of a second business partner with whom to collaborate and run the business presents the opportunity for more growth, more profitability and division of labour. A partnership venture helps entrepreneurs achieve this, as the partners can collaborate with each other for the goal of growing the business to greater heights.
Additionally, unlike in a sole trader business where the incapacitation of the business owner means the business will have to stop trading until the business owner becomes available again, in a partnership, the incapacitation of one partner will not result in the shutting down of business transactions. This is because the other partner(s) will keep the business running until the incapacitated partner recovers.
The partnership contract can also ensure this collaboration is maintained to by providing that certain decisions cannot be taken by a partner unilaterally without the express consent of the other partners.
As a result of less formalities required, a partnership is easier to start as the partners just merely need to register the business with the tax authority and begin trading. There is no need to file any formation documents or create a share structure (as is the case with a limited company). The partners can begin trading almost immediately after tax regsitrations of the individual partners. This ease of forming and starting a partnership makes it a particularly desirable structure for running a business.
In comparison to a sole trader, a partnership provides the business with access to more capital. For one, all the partners in the partnership will contribute towards the capital needed to start the business. This access to capital also scales with the number of partners involved in the partnership. In other words, the more partners in the partnership, the more capital they can access to start the business. Better access to capital also means the possibility for growth of the business is much better than a sole trader or sole shareholder company.
Unlike a company/corporate entity, a partnership is not burdened by external regulation on how it should be run. For example with a company, it is first governed by the Companies Act 2006 and then by the Articles of Association of the company. Whereas, a partnership is run on the basis of the contract between or among the partners.
As such, "regulation" of the partnership is determined by the provisions and obligations imposed in the partnership agreement. On matters where such contract is silent however, the Partnership Act 1890 will take precedence. This limited external regulation means that the partners have more freedom to run the partnership in the way they see fit.
The flexbility of a partnership means that the partners can choose to change or evolve the partnership into another type of partnership (e.g. from a general partnership to a limited liability partnership) or a change in the type of business itself (e.g. from a partnership to a company).
In essence then, a partnership provides the partners with the opportunity to modify their business according to its growth. For example, if a partnership grows significantly to the point where it will be better as a company, the partners can choose to move in this direction and carry out the appropriate formalities needed to change the partnership into a company. Similarly, if the partners wish to change the structure of a general partnership to a limited liability partnership, they can do so.
Nonetheless, while a partnership has its uses and areas where it is advantgeous, it also has its limitations. These include:
A partnership, similar to a sole trader has unlimited liability of the partners in the partnership. Unlimited liability means that the partners are personally responsible for the debts that the partnership accrues.
This unlimited liability can be a limitation because in reality, every business runs the risk of accruing debts at some point in its life cycle. Such common debts include bank loans, stocks purchased on credit, financed vehicles and machinery and so on. In the case of a partnership, it becomes all the more necessary to not accrue excess debts. From a business standpoint, this can limit the extent of the partnerships growth as it is common to use debts and loans to expand the business toward more growth.
Joint and Several liability means that each partner will bear liability in regards to any damages awarded or claim instituted against the partnership.
For example, if a client issues a claim against the partnership and is awarded damages of £10,000, the partners of the partnership will all share the liability and be responsible for paying the damages of £10,000.
This means that even if the libility is as a result of a single partner's fault, all other partners will share the responsibility for that liability and any damages awarded. As such, each partner has to police the actions of the other partner(s) and make sure they do not become liable for another partner's shortcomings.
Because the individual partners are not separate from the partnership, a partner becomes an agent of the partnership such that in a commercial sense, they are always acting on behalf of the partnership. This places a great deal of responsibility on the partners in the partnership as they are never really separate from the business. The further implication of this is that each partner has the somewhat onerous task of monitoring the other partner(s) to ensure that their personal actions do not negatively affect the reputation or profitability of the partnership.
In a partnership, the link between the partners and the partnership means that where the partners have a conflict, it can result in the end of the partnership. Unlike a sole trader who is answerable to no other person, or a company where a conflict with a shareholder and their consequent departure does not mean the end or fundamental restructuring of the partnership. The success of a partnership venture therefore depends on how severe potential conflicts are resolved between/among the partners.
The decision to form a partnership is a fundamental one that needs to be considered carefully when the business is being formed. It is therefore very important for business owners to pay attention to these benefits and limitations of partnerships in deciding whether it is the most appropriate structure for their kind of business they want to carry on.