What Are the Disadvantages of Partnerships?
Partnerships are the simplest and most common form of business arrangements besides sole proprietorships. There are a few different types of partnerships -- general, limited, and limited liability partnerships -- each with its own advantages and disadvantages. For instance, limited partners (typically investors) have the opportunity to do well financially without being involved in the day-to-day activities of the business, while general partners are liable for any debts or legal judgments against the business. As with any business legal structure, you want to weigh the pros and cons of each and determine which is the best fit for your organization.
There are some notable disadvantages of partnerships that must be considered. For one, the informality of the relationship means that there are fewer protections for the parties to the agreement, including a lack of limits on liability, difficulties transferring an ownership stake, and potentially unclear roles and authority. A summary of these disadvantages follows.
Generally, the members of a partnership are exposed to unlimited liability for the acts of the partnership as a whole. This means that if the business as a whole becomes indebted and insolvent, the partners' personal assets might be exposed to cover the debts.
Of course, this shortcoming can be addressed by forming a partnership between two corporations. Corporations have limited liability and can be partners in a partnership as well.
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.
On similar lines, by default, a partnership is dissolved as soon as one of the members dies, retires, resigns, files for bankruptcy, or otherwise quits. This can mean a sudden and unexpected end to a profitable business. A corporation, on the other hand, requires many more steps to be undertaken in order to end its existence, which makes its existence much more predictable.
Another drawback of informal partnerships is the potential vagueness of each person's responsibilities, both to 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, can enter into contracts, and by the same token, 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.
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Whether you plan to form you company as a partnership, LLC, or some other type of legal structure, you should make sure you understand the advantages and disadvantages of each. If your company is already up and running and you have questions about liability or any other matters, you may benefit from speaking with a legal professional. Contact a qualified attorney in your area for a free initial case assessment to learn how they can help.