The Partnership Agreement

The impact of disputes can be lessened if the partners have executed a well-planned partnership agreement that specifies everyone’s rights and responsibilities. The agreement might provide such details as the following:

• Amount of cash and other contributions to be made by each partner
• Division of partnership income (or loss)
• Partner responsibilities—who does what
• Conditions under which a partner can sell an interest in the company
• Conditions for dissolving the partnership
• Conditions for settling disputes

Unlimited Liability and the Partnership

Figure 4.4 "General Partnership and Unlimited Liability" shows that a major problem with partnerships, as with sole proprietorships, is unlimited liability: each partner is personally liable not only for his or her own actions but also for the actions of all the partners. In a partnership, it may work according to the following scenario. Say that you’re a partner in a dry cleaning business. One day, you return from lunch to find your establishment on fire. You’re intercepted by your partner, who tells you that the fire started because he fell asleep while smoking. As you watch your livelihood go up in flames, your partner tells you something else: because he forgot to pay the bill, your fire insurance was canceled. When it’s all over, you estimate the loss to the building and everything inside at $1.2 million. And here’s the really bad news: if the business doesn’t have the cash or other assets to cover losses, you can be personally sued for the amount. In other words, any party who suffered a loss because of the fire can go after your personal assets.

Figure 4.4 General Partnership and Unlimited Liability

Limited Partnerships

Many people are understandably reluctant to enter into partnerships because of unlimited liability. Individuals with substantial assets, for example, have a lot to lose if they get sued for a partnership obligation (and when people sue, they tend to start with the richest partner). To overcome this defect of partnerships, the law permits a limited partnershipPartnership made up of a single general partner (who runs the business and is responsible for its liabilities) and any number of limited partners., which has two types of partners: a single general partner who runs the business and is responsible for its liabilities, and any number of limited partners who have limited involvement in the business and whose losses are limited to the amount of their investment.

Advantages and Disadvantages of Partnerships

The partnership has several advantages over the sole proprietorship. First, it’s relatively inexpensive to set up, and it subjects you to few government regulations. Second, it brings together a diverse group of talented individuals who share responsibility for running the business. Third, it makes financing easier: The business can draw on the financial resources of a number of individuals. The partners not only contribute funds to the business but can also use personal resources to secure bank loans. Fourth, continuity needn’t be an issue because partners can agree legally to allow the partnership to survive if one or more partners die. Finally, partners pay taxes at the income tax rate for individuals; they don’t pay any special taxes.

Figure 4.5

Partnerships can have many advantages, but there are disadvantages to consider as well.

© 2010 Jupiterimages Corporation

Still, there are some negatives. First, as discussed earlier, partners are subject to unlimited liability. Second, being a partner means that you have to share decision making, and many people aren’t comfortable with that situation. Not surprisingly, partners often have differences of opinion on how to run a business, and disagreements can escalate to the point of actual conflict; in fact, they can even jeopardize the continuance of the business. Third, in addition to sharing ideas, partners also share profits. This arrangement can work as long as all partners feel that they’re being rewarded according to their efforts and accomplishments, but that isn’t always the case.

While the partnership form of ownership is viewed negatively by some, it was particularly appealing to Ben Cohen and Jerry Greenfield. Starting their ice cream business as a partnership was inexpensive and let them combine their limited financial resources and use their diverse skills and talents. As friends they trusted each other and welcomed shared decision making and profit sharing. They were also not reluctant to be held personally liable for each other’s actions.