The Disadvantages and Advantages of General Partnerships

Updated September 30, 2022

A general partnership is a business arrangement where two or more businesses or individuals come together to share in all assets, profits and liabilities of a partnership business. These experts, also known as partners, combine their resources and expertise to establish a corporation or company. Understanding the concept of general partnership can help you gather enough knowledge on how individuals and businesses form partnerships. In this article, we explore the advantages of general partnership, discuss its disadvantages, define the concept, explain how it works, highlight its features, and mention what partners consider before joining general partnerships.

What is the advantage of general partnerships?

The major advantage of general partnerships is the flexibility that allows the partners to work out the terms related to operations, expenses, debts, and profits. This structure can also facilitate a well-managed administration and clear rules and policies. Here are some advantages of general partnership:

Easy to form

Like a sole proprietorship, forming a general partnership requires formal procedures and the drafting of essential documents, such as the contract of partnership that highlights the obligations of each partner in the business. It's also relatively cheaper to start than other businesses like limited liability companies. After forming a partnership, the involved parties can choose to centralize or decentralize the management, depending on their ideals.

Default business entity

A general partnership ensures a stable business entity, so long as the partners agree on the business. This implies that they don't need an overly drafted legal document to begin their activities. They can start the business by agreeing on the main points that allow functionality. Most provinces in Canada don't need maintenance activities.

Diversity within leadership

A general partnership contains partners from several cultures and backgrounds to fulfil a common goal. The diversity within the coalition ensures a successful business and optimization of profits. Because of the various experiences of the different partners, a business can perform more efficiently by trying new business strategies. Different leaders may add different perspectives and skills to the vision of the business.

Pass-through taxation

Since there's no exact taxation method of the partnership businesses, whatever profit and loss the business incurs falls under the partners' personal tax returns. It means that the business might pass through basic tax structures. This helps limit liability in the business' income tax since it goes to the personal taxes of the partners. Partners are also accountable for the business' assets and liabilities.

Equal rights distribution

A properly formed general partnership empowers all the partners with equal rights to manage the business' activities. It ensures that every partner agrees to take up responsibility in the business. It also ensures an understanding amongst the partners of their job designation and managerial obligations.

Flexibility

General partnerships provide the partners with a more flexible method of structuring their business. It also enables them to control the business activities more adequately. Unlike corporations and other business structures, general partnerships don't have strenuous and red-tapes in their decision-making process. The level of flexibility in a general partnership allows the partners to implement new ideas and make quicker and smarter decisions affecting the business.

Easy conversion

A partner typically holds responsibility for 50% of liabilities the business incurs. Invariably, a business with five partners reduces the liability percentage to 20% per partner. Although a general partnership doesn't fully ensure a business without risks, it's easily convertible into a limited liability company. This easy conversion helps to mitigate the disadvantages of partnerships.

Disadvantages of general partnerships

General partnerships have some disadvantages, which can result in debt and dissolution. Below are some disadvantages of general partnerships:

Potential personal liability

General partnerships aren't independent entities like corporations that may have plenty of establishments. This implies that they can't financially protect their personal assets like in other business corporations. Since it operates as a sole proprietorship, every partner may face personal liability in the event of an issue of liabilities. They may give up some of their assets, depending on the cost of the liability. Also, every partner is liable for the actions and mis-actions of another partner. This implies that if one partner incurs a great liability from poor decisions, the consequences may affect the entire business.

Easy dissolution

A partner can easily end a general partnership if an associate leaves or dies. In the absence of even one partner, a general partnership may end. When a general partnership ends, the partners evenly share the assets and may plan a new partnership agreement to recommence the general partnership with the remaining partners if they wish. If the partners don't plan for such possibilities at the prior general partnership agreement, it may become a problem and disorient the business for that period.

Difficult funding process

Individual partners may have personal taxation and general debt liabilities over which they have no control. This may discourage potential investors from engaging in the business. When the business can't get investors and other funds, it becomes harder to operate. This makes a general partnership smaller than limited liability companies and corporations.

License requirement

Some businesses may have permits to operate even without their license in some regions. The same doesn't extend to general partnerships as they require their business license before engaging in any business activity. For instance, a restaurant business requires certifications and other paperwork from a public health inspector before beginning the business.

Liable for self-employment taxes

Partners in a general partnership may be liable for self-employment taxes. Since they classify as self-employed persons that engage in performing services for their businesses, their net gains and losses may be liable for self-employment tax. This is usually not the same for other business structures like limited liability companies.

No transfer of interest

Unless the general partnership agreement says otherwise, a partner ideally can't transfer or divest themselves of their interest in the business. Since transferring interest has no stringent rules, some regions use the unanimous voting style. This may force partners to issue intentions to leave the general partnership.

What is a general partnership?

A general partnership is an agreement by two or more individuals or businesses to engage in joint business activity. In this arrangement, each partner shares gains they make from the general partnership agreement. Also, partners share other financial responsibilities, such as debts, obligations, and liabilities equally. This implies that, while they collectively share business profits, they also share losses. You can define a general partnership as a business arrangement where at least two parties corroborate in business activity and agree to share all assets, gains, and financial duties.

A general partnership involves persons, corporations, or trusts coming together to form a lasting partnership for a specific period. For the jointly owned business period, the partners draw up a general partnership contract that defines each partner's rights, obligations, and responsibilities. This agreement also consents to unlimited liability, which is the seizure of some of their assets to settle pending liabilities from the business. In a general partnership, individual partners are liable for their taxes, as taxes don't generalize from the general partnership.

How do general partnerships work?

A general partnership is ideal for businesses synonymous with sole-proprietorships because they're relatively medium-scale businesses that require little or no employees, and low funding. One difference between a sole proprietorship and general partnerships is that they structure the latter to suit medium-scale companies that involve over one owner. Here is how general partnerships work:

General partnerships may only require an oral or parole contract, but it's beneficial for the partners to draft a general partnership agreement at the start of the association to record the legal relationship between them.
Partners may designate managerial duties to a non-partner. The general partnership is still a business, so it may require skilled management that none of the partners may provide.
General partnerships are one of the few business entities that individuals can establish without a compulsory written agreement. When the partners agree to form a partnership, they share everything equally amongst themselves until they fulfill the partnership's purpose.
General partnerships end in the instance where one partner leaves the society, and the remaining partners can plan a new one.

What prospective partners look for before joining a partnership

Before starting and structuring a business, partners may consider how they want to fund their organization. It's beneficial for them to understand their responsibilities, liabilities, and personalities to select the best business structure to materialize their ideas. Below are certain factors potential partners consider before joining a general partnership:

Structure and brand: Before entering into a partnership with other parties, they might understand their business structure and how their brand connects with other people in the partnership.
Respect and trust: Successful partnerships need mutual respect and trust among partners. To operate in a stress-free workplace, potential partners trust the vision, decision-making abilities, and ambitions of other partners in the partnership.
Aims and values: Before entering a partnership agreement, they check to see if other partners share their goals and values. The partner's primary goal may be to generate money, but another may be to grow their company.