Partnership

What It Means

When two or more people combine resources to form a profit-seeking business, that arrangement is called a partnership. In this sort of organization all profits and debts are shared proportionately according to the resources that each partner put in at the beginning. Partners are also personally liable (responsible) for all losses and damages suffered by the business. For example, if two college students each invested $250 to begin a painting business, and they made $4,000 by the end of the first summer, each would receive $2,000. On the other hand, if on the first day of the job one of the painters broke a large window that cost $3,000 to replace, both partners would have to draw $1,500 from personal funds to cover the damages. In this way a partnership is different from a corporation, a kind of business in which the owners cannot be asked to draw from personal accounts to cover damages.

There are two basic types of partnership: general and limited. In a general partnership, such as the arrangement described above, partners own and manage the business together. In a limited partnership one or more general partners manage the business and assume personal liability for losses, while limited partners contribute money, work space, or other resources but are not involved in the management of the enterprise. This is why they are sometimes referred to as silent partners. Limited partners are only liable for the amount they invested in the business.

When Did It Begin

Business partnerships have existed since early civilization; the oldest known reference to such an arrangement dates back to the eighteenth century bc , with a law code of the ancient empire of Babylonia (in present-day Iraq). This evidence suggests that, for as long as there have been people willing to pool resources to make more money, there has also been a need for rules and written documents to settle disputes between partners.

In Europe partnerships (which were then called commendas) first arose in the eleventh century, when trade relations between Italy and the eastern Mediterranean began to grow. These business partners created agreements based on a combination of Roman commercial law and Islamic religious law. Borrowing from this original model, the English business community of the 1600s had partnerships called societas. More modern versions of these businesses spread widely in England throughout the 1800s, and in order to regulate their activities, the country formally ratified the Partnership Act in 1890. The United States in 1914 passed its Uniform Partnership Act, which was adopted by all the states except Louisiana. The act underwent a series of modifications between 1994 and 1997. By the start of the twenty-first century most states had adopted the Revised Uniform Partnership Act of 1997.

More Detailed Information

A partnership is much easier to create than a corporation, which usually requires official authorization from a state government and a yearly licensing fee. To create a business partnership, no formal papers need to be filed with any state or federal agency, and there is no licensing fee. Two or more individuals just need to reach a verbal agreement and begin business.

Most partnerships, however, are formed through a written agreement called the articles of partnership, which outlines each party’s rights and obligations. In the absence of a written agreement, partnerships in the United States are governed by either the Uniform Partnership Act or the Revised Uniform Partnership Act, depending on the U.S. state that the partnership is in. The main provisions of both acts are the same. They say that partners must share profits, losses, and obligations and that the partnership must be a for-profit business. Charitable organizations and nonprofit groups can not legally be considered partnerships.

There are many advantages to structuring a business as a partnership rather than as a corporation. The primary advantage is flexibility: the partners themselves manage the business and need only consult each other to change daily operations. That is not often the case with traditional corporations, which consist of stockholders (people who have invested money in the company and therefore own it), a board of directors (elected by the stockholders to represent them), and officers (who run the daily operations). Each of these has a say in the company’s major decisions, so changes to corporations often involve layers of bureaucracy. Partnerships also offer an important tax advantage over corporations, which are, in effect, taxed twice: the corporation itself is taxed for all profits, and individual stockholders also pay taxes on their shares of the profits. With a partnership, however, all profits go directly to the partners, who only pay individual income tax on what they earn from the business.

There are some disadvantages to maintaining a partnership instead of a corporation. Most of these have to do with liability. To be liable means that each of the partners is personally responsible for covering any money the partnership owes. Furthermore, a decision made by one partner is binding to all partners, whether they know about the decision or not. For example, if three partners set up a small computer-merchandise shop and one of them agrees to pay a distributor $20,000 for equipment, then all partners are liable for that $20,000. If the three partners cannot pay the bill, the distributor can sue them for the money. If the partner who signed the agreement has no personal savings, the distributor can recover funds from either or both of the other partners.

Recent Trends

Because corporations experience what is called double taxation by the federal government (the corporation is taxed as an entity for its profits, and then individual shareholders are taxed), many entrepreneurs prefer to pay fewer taxes by running their businesses as partnerships or S corporations. The latter is a type of business entity that consists of 100 or fewer shareholders and receives the benefits of incorporation while being taxed as a partnership. Between 2000 and 2004 the number of partnerships in the United States grew by 23 percent, and the number of S corporations increased by 21 percent. Many states reacted by rewriting their business tax laws in an effort to raise revenues. States such as New Hampshire, Ohio, and Tennessee, for instance, began to impose what have been called franchise taxes or commercial activities taxes on some partnerships and S corporations.