Partnership

Definition

A partnership in business and finance is a legal and economic arrangement where two or more individuals or entities collaborate to jointly own and manage a business.

What is a partnership?

Partnerships are a common form of business structure, allowing participants to combine their resources, skills, and expertise to pursue a shared business goal. 

There are various types of partnerships, each with its own characteristics and legal implications:

1. General partnership (GP): All partners share equal responsibility for the management and liabilities of the business. Profits, losses, and decision-making authority are typically divided equally among partners. General partners have unlimited personal liability for the debts and obligations of the business.
2. Limited partnership (LP): A limited partnership has both general partners and limited partners. General partners have management authority and unlimited personal liability, while limited partners contribute capital but have limited involvement in management and liability.
3. Limited liability partnership (LLP): An LLP is a hybrid form of partnership that provides limited personal liability to all partners. Each partner is protected from personal liability for the actions or debts of the partnership, but they may still be personally liable for their own professional negligence or misconduct.
4. Limited liability limited partnership (LLLP): An LLLP is a variation of a limited partnership where all partners, including general partners, have limited personal liability.

A partnership is typically established through a formal written agreement that outlines the roles, responsibilities, and rights of each partner. 

Advantages of partnerships

1. Pooling of resources and expertise: Partnerships allow individuals or entities to combine their financial resources, skills, and knowledge to achieve common business objectives.
2. Shared risk and liability: In certain partnership structures, partners have limited personal liability, protecting their personal assets.
3. Flexibility and decision-making: Partnerships offer flexibility as partners have the ability to customise the terms in their agreement.
4. Tax advantages: Partnerships generally do not pay income taxes at the entity level. Instead, profits and losses are passed through to individual partners, who report them on their personal tax returns.

Challenges and considerations

1. Shared decision-making: Disagreements among partners can arise, so clear communication and conflict resolution mechanisms are crucial.
2. Shared profits and losses: Partners must agree on how profits and losses are distributed, which can sometimes be a source of tension.
3. Liability issues: In general partnerships, partners have unlimited personal liability, meaning their personal assets may be at risk to cover business debts and liabilities.
4. Succession planning: Planning for the departure or addition of partners, or for the dissolution of the partnership, requires careful consideration and should be addressed in the partnership agreement.

How is a partnership taxed

A partnership itself is not taxed at the entity level. Instead, it passes through its income, deductions, and credits to the individual partners, who report their share on their personal tax returns. Each partner is taxed on their own share of the partnership’s income, regardless of whether they receive actual distributions. The partnership files an informational tax return which reports the partnership’s financial activity.

Example of a partnership

Imagine two friends, Alice and Bob, decide to start a small graphic design agency together. They formalise their business relationship by establishing a partnership called “AB Design Studio.”

As partners, Alice and Bob share equally in the profits, losses, and decision-making responsibilities of AB Design Studio. They draft a partnership agreement outlining key aspects such as profit-sharing arrangements, roles and responsibilities, decision-making processes, and procedures for resolving disputes.

Together, Alice and Bob collaborate on client projects, market their services, and manage the day-to-day operations of AB Design Studio.