What Are the Disadvantages of Partnerships?
When small business owners decide to team up, they might start a business partnership. Besides sole proprietorships, partnerships are the simplest type of business entity. There are a few different types of partnerships: general, limited, and limited liability partnerships. Each has its own advantages and disadvantages. This business structure means that two or more people own the business together.
Each business partner brings different skill sets and work ethics to the table, which can create a successful partnership. But just like a coin has two sides, partnerships have disadvantages, too.
While entrepreneurs might see the advantages of a partnership, like sharing the startup costs and having someone to share decision-making with, they should also consider the disadvantages of a business partnership. Creating a business plan can help, but sometimes problems come up that no one expects. Let's discuss some of the most notable disadvantages of partnerships that must be considered.
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Liability in Partnerships
In a general partnership, every business partner can be responsible for the business debts. This means if the business doesn't have enough money to pay back what it owes, individual partners might have to pay out of their own pockets. This is called personal liability. Even if one partner makes a mistake, all partners could be on the hook for it. If the business gets sued, personal assets like houses and savings could be at risk.
This is different from a corporation or limited liability partnership (LLP), where the law sees the business as its own legal entity. Without the right legal advice, small business owners in a general partnership could face big risks.
Transferability in Partnerships
If a business partner wants to leave or sell their part of the business, it's not always easy. Unlike shares in a corporation that you can often sell to anyone, partner shares in a business partnership need the other partners' consent. Absent an agreement to the contrary, the default rule in partnerships is that one person's stake cannot be transferred to another without prior consent from all of the remaining partners.
This inflexibility is especially undesirable when the parties have existing disagreements, making having an exit strategy very difficult. If a partner passes away or just wants out, the partnership might have to end if they didn't plan for what to do in their business plan. That's why it's important to talk to a lawyer and set these things up when the partnership starts. If not, finding a new partner or transferring ownership could get messy.
Instability in Partnerships
Business partnerships can sometimes be shaky. When partners don't agree on decision-making or the management of the business, it can cause disagreements. If one person isn't pulling their weight or their work-life balance isn't right, it can affect the whole business. Plus, if a business partnership doesn't have a clear process for how to handle things when someone wants to leave or when bringing in a new partner, it can create instability. In a small business, stability is extremely important.
Unclear Authority in Partnerships
Another drawback of informal partnerships is the potential vagueness of each person's responsibilities. This can apply to both those in the partnership and to those outside of the arrangement. A traditional partnership is an equal stake with equal authority distributed between the members. There is no hierarchy of authority. To third parties, this means that all partners act on behalf of the partnership. They can enter into contracts and bind the partnership into unwanted agreements.
Even with a partnership's limitations, it still might prove to be a superior option for many due to its flexibility and informality. Many of the limitations can be addressed with a carefully drawn partnership agreement or by adopting an alternative business entity, such as a limited liability company.
Get Legal Help With Your Partnership Questions
Whether you plan to form your company as a partnership, LLC, or opt for incorporation into a different type of legal structure, you should make sure you understand the advantages and disadvantages of each, as well as the potential disadvantages of a partnership. If your company is already up and running or a new business, if you have questions about liability or any other matters, you may benefit from speaking with a business attorney in your area.
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