Establishing a business alone could be difficult, but having a helping hand who is your equal is a great way to take off burden from your shoulders and helps you increase your network to the journey of success.
Choosing the correct partner to support you in the business is necessary, but before taking the final decision, it is important that you understand the advantages and disadvantages that come along a General Partnership, as well as the legal requirements one needs to follow in order to get started.
Let’s get into the blog to know more!
Advantages and Disadvantages of General Partnership
Advantages of General Partnership
Easy to Form
A general partnership is as easy to form as sole proprietorship firm. With few formalities and documents such as a detailed partnership agreement which outlines the responsibilities of each partner in the business is required for the formation of a partnership business.
Upon formation, the partners can decide whether to they want to keep their management centralized like a corporation or decentralized as per their preference.
Default Business Entity
As long as each partner in a general partnership agrees over the guidelines for their business among themselves, there is no requirement of drafting a detailed legal business document before beginning the operations. Mostly states in the United States do not require maintenance activities either.
Diversity Within Leadership
As in a general partnership, people from unique backgrounds and cultures come together bringing their resources in order to form a general partnership, it can lead to a successful business and making profits.
It means that there is diversity within leadership of a general partnership as compared to other business structures. The experiences and skills of diverse people can help build an effective and profitable business which has the power to last in the longer run.
As there is no definite taxation of the business in a general partnership, the income and losses incurred by the business are reported as personal tax returns of each partner which gives them the advantage of the pass-through taxation structure if the company is based in the United States.
In case of any credits or debits in the business account, it would be transferred over to the personal returns, which helps in limited liability in the income taxation of the business.
Equal Rights Distribution
Upon the formation of a general partnership business, all the partners involved have equal rights to manage the operations of the business. This gives a reason to large partnerships to develop an agreement which outlines each partner’s roles and responsibilities within the company.
The last confusion or disagreement you would want is that all 5 people are trying to be the top CEO while getting no actual work done.
Easy Conversion to Other Business Structure
In a general partnership, a partner is responsible for 50% of liabilities incurred by the business. If in case 5 partners are involved, the liability percentage drops down to 20% each, however, it does not promise risk-free business as the personal assets are up in danger.
For this liability issue, general partnerships eventually turn into an LLC in order to reduce the risks or disadvantages of a partnership structure.
Disadvantages of General Partnership
Potential Personal Liability
As general partnership does not act like an independent entity, which means they do not have the advantage of financial protection of personal assets such as in a corporation or other kinds of business structures.
It works more like a sole proprietorship, wherein, if there is an issue of liabilities or a case of losses incurred, each partner faces a potential personal liability depending on the cost and their personal assets are at risk.
In case of any unexpected reason a partner decides to leave, or happens to die, the business and partnership can be terminated easily. It is necessary to terminate the presence of the business in case of absence of even one partner.
Dissolution of the business will require the partners to equally distribute the assets among themselves and set up a new general partnership agreement in order to restart the business with the remaining partners. Therefore, it is always advised that the partners set up an agreement before the beginning of the partnership to avoid the hassle later.
Difficult Funding Process
Each partner in a general partnership has personal taxation liabilities, along with general debt liabilities, which cannot be controlled by them directly and resents the investors to be a part of such a business structure.
It makes it difficult for the business to find investors or other finance funding options to raise capital outside of the personal networks of the partners. Therefore, a general partnership usually stays smaller in size as compared to an LLC or a corporation.
In the United States, some states allow any kind of business structure to operate immediately without a license, however in case of a general partnership, they must wait for the business license receipt before serving their first customer.
In businesses like restaurants, they require certification or other necessary documentation from the health inspector before opening up the business.
Liable for Self-Employment Taxes
As the partners in the general partnership are classified as self-employed individuals performing services for the business, their net earnings or losses including the distributive share of income is liable for the self-employment tax in the United States.
As of 2022, self-employment tax is 15.3% with 2.9% going towards Medicare tax and the remaining towards Social Security.
No Transfer of Interest
If not specified in the general partnership agreement, a partner is not allowed to transfer or divest themselves of their interest in the business of their own. Since there are no rigid regulations for a transfer of interest, some states adopt the unanimous voting method.
It builds more pressure on the initial founding of the business, as in this case each partner will now be forced to issue or file an intent to abandon the partnership instead.
Now that you know the pros and cons of forming a general partnership, you can now take your decision wisely. Every new business venture has risks involved, but general partnership is easy to form with flexible regulations to run smoothly.