Partnership companies/firms are created with a sole objective of bringing together 2 or more people (referred as partners), with a legally bound agreement that denotes the partners share in the entity and their co-operation to advance in a business objective.
Limited Partners and General Partners
- Limited Partner: Limited partners serve as investors.
- General Partners: The general partners own and operate the business and assume liability for the partnership.
According to the Oxford Dictionary for the Business World. “Partner is a person who shares or takes part in activities of another person. Partnership is an association of two or more people formed for the purpose of carrying on a business”
According to Prof. L. H. Haney, “Partnership is the relation existing between persons competent to make contracts, who agree to carry on a lawful business in common, with a view to private gains.”
In the words of Prof. Macnaughton, “Partnership results from the desires of business to take advantages of complementary ability and to raise more capital”
“Partnership is the relation which subsists between persons, who have agreed to combine their property, labour or skill in some business and share the profits thereof between them” :Indian Contract Act, 1872.
“It is the relation between persons who have agreed to share the profits of a business carried on by all or anyone acting for all”. Section 4 of Indian Partnership Act, 1932.
“Partnership is an association of two or more persons who carry on as co-owners, a business for profit” :Uniform Partnership Act, U.S.A
Advantages of Partnership
(i) Ease of Formation
Any two persons capable of entering into contract can start partnership. The partnership deed can be oral or written. Registration is not compulsory. Thus, partnership is very easy to form. However, business conditions or requirements may force partnerships to be formed through a partnership deed, which is in writing. For example, banks may not allow a partnership firm to open a banking account unless there is a written partnership deed.
(ii) Flexibility of Operations
There is considerable freedom in carrying out business operations. There is no need for taking approvals from Government or any other authority, to change the nature, scope or location of the business.
(iii) Greater Financial Resources
Partnership combines the financial strength of all partners, as the liability of partners is joint and several. Not only is the ability to contribute capital greater, it also enhances the borrowing capacity of the firm.
(iv) Greater Managerial Resources
Partnerships are often formal by people looking for advantages of synergy. If one partner has technical knowledge, other could be marketing or finance expert. Thus, the managerial resources of the firm are enhanced. The financial resources available with the firm enables the firm to employ a good manager on salary basis for taking care of the business in a professional manner.
(v) Greater Creditworthiness
When a lender evaluates the proposal for loan, he looks at the creditworthiness of the borrower. A partnership firm, by definition, has more than one person responsible for the business. All partners are jointly and severally liable for the debt taken by the firm. The personal assets of all the partners can be used for repayment of the loan. All this gives greater confidence to the lenders. Thus, a partnership firm enjoys greater creditworthiness and therefore raise more debt for the business.
(vi) Balanced Judgement
In a partnership, the day to day management might be taken care of by one or few partners. However, in case of major issues, partners are likely to discuss the circumstances and arrive at a balanced judgement. Decisions are unlikely to be taken in haste, or in emotion.
Partnership can benefit from division of labour. Partners may choose to specialize in an area of interest. Partners can clearly define responsibilities and duties amongst themselves. This will result in expertise in management, apart from increase in efficiency, thereby maximizing profits.
(viii) Maintenance of Secrecy
A partnership firm is a closely held business. It is not required by law to share its performance and position with others. Thus, all knowledge about the firm is restricted to only the partners of the firm.
(ix) Personal Contacts with Staff and Customers
A partnership concern is a relatively small organization, whose activities can be managed by a group of people. Thus, partners keep in close contact with customers and staff. They are thus able to note the changing tastes and attitudes and react faster to such changes.
(x) Economies in Management
Partners have a stake in the profits of the business. They ensure that wastage is kept at the minimum. All expenses are closely supervised. Thus, expenses of management are controlled.
(xi) Conservative Management
Partners have unlimited liability. Unlimited liability prevents the partners from taking reckless decisions. They not only ensure that the decisions taken by them are acceptable to all, but also confirm that no other partner is acting needlessly aggressive.
(xii) Protection of Minority Interest
A partner being jointly and severally liable for any action of the firm, he has a right to stop the firm from taking action that is not in the interests of the firm. Such a partner cannot be ignored even if majority of partners feel otherwise. Decisions of partnership need the consent of all partners.
(xiii) Incentive to Hard work
Partners have share in the profits of the firm. Partners put in hard work and try to increase profits of the firm. A sincere and committed effort brings in extra rewards.
(xiv) Risk Reduction
The profits and losses are shared by all partners. Similarly, if the firm is unable to meet any of its payment obligations, all partners are responsible. Thus, partnership offers risk reduction as the risk is spread across partners.
(xv) Greater Scope for Expansion
As number of partners is larger, the firm can plan for faster expansion. It can also have geographical expansion, as a partner can be mobile and sufficiently experienced to handle the organizational activities from a new place.
(xvi) Easy Dissolution
It is very easy to dissolve the partnership firm. Any partner can ask for dissolution of firm by giving a 14 day notice. The firm can be dissolved on death, insolvency or lunacy of any partner. No legal formalities are required.
The Income Tax Act, 1961 treats a Partnership as a separate ‘person’ and its tax is calculated separately. This allows scope for partners to do tax planning and reduce total tax payable to minimum.
Disadvantages of Partnership Firm
(i) Unlimited Liability
Partners become fully liable for all claims against the firm to an unlimited extent. The partner might lose all the savings of his life on account of a loss or a mistake in business. This is one of the reasons that the selection of a partner or association with a like-minded partner is the most important thing in forming a partnership business.
(ii) Restriction on Transfer of Interest
One of the golden rules of any investment is that there must be an easy exit. If partner needs money, or is not in agreement with others, he cannot transfer his interest in the firm to outsiders without the consent of outsiders. A partner will not be able to reduce or increase his stake in the partnership.
(iii) Inadequacy of Capital
The number of partners in a firm is restricted to a maximum of twenty persons. Thus, a partnership firm may not be in a position to raise the required capital to finance its expansion plans. Hence, businesses that need large amounts of capital are generally organized as Joint Stock companies. For example, an oil refining business like Reliance Industries Limited or a car manufacturing business like Tata Motors Limited, cannot be imagined as Partnership firms.
(iv) Mutual Conflicts
Partnership requires close cooperation and a lot of understanding amongst partners. If there is a serious difference of opinion amongst partners, with different partners trying to pursue different goals then it is not good for the health of the business. Friction between partners will eventually lead to closure of business.
(v) Uncertain Continuity
Partnership may be dissolved on account of death, insolvency, insanity or incapacity of any of the partners. There is always a serious threat to continuity of business in its existing form. Hence, partnership firms are not suited to businesses requiring long term capital and plans.
(vi) Delay in Decision Making
While day to day management is handled by one or more partners independently, any major decision requires the consent of all partners. A discussion and consensus on decision to be taken might be time consuming, resulting in the firm losing out on prompt action.
(vii) Risk of Implied Authority
A partner can bind all other partners of the firm by his actions. This is a great risk to the other partners, as any hastily taken action may result in wiping out the life savings of all partners. It is seen that mistrust and wrong decisions by managing partners usually lead to dissolution of partnership firms.
(viii) Lack of Public Confidence
The affairs of the firm are not subject to public scrutiny. The performance and position of the firm is not published. Hence, the firm does not enjoy any public confidence.
(ix) Aversion to Risk
The liability of all partners is unlimited. Also, the partners are jointly and severally liable. In other words, a wrong step taken by one partner can result in all or some of the partners becoming bankrupt. Keeping this in mind, partners have a very high aversion to risk.
(x) Limited Scope for Expansion
A partnership firm can have only a limited number of partners. The liability of these partners is unlimited. Therefore, their ability to take risk is limited. This limits the ability of the firm to expand and grow.
(xi) Continuation of Responsibilities
Normally, the responsibilities pertaining to a business end with closure of the business. However, in case of Partnership firms, unless the liability of the firm is limited (LLP or Limited Liability Partnership), the responsibility of partners continues even after the firm is closed down (dissolved). This continues till the claims of all outsiders are completely settled.
(xii) No Independent Legal Status
Partnership firm is not separate or distinct from its members. It does not have a separate legal entity of its own. Partners enter into contracts on behalf of each other.