There are many ways to form a business, each with its own distinct advantages and drawbacks. In fact, there are four main types of business entities: a partnership, a sole proprietorship, a corporation and a limited liability company.
A partnership business, by definition, consists of two or more people who combine their resources to form a business and agree to share risks, profits and losses. Common partnership business examples include law firms, physician groups, real estate investment firms and accounting groups.
By comparison, a sole proprietorship puts all of those responsibilities on one person, while a corporation operates as its own legal entity, separate from the individuals who own it. A limited liability company, or LLC, is a hybrid of a partnership and a corporation, allowing owners to take on profits and losses without any personal liability or taxes on the business itself.
For many individuals, going into business with a partner is a chance to forge experience, expertise and endeavors with others. To maximize some of these benefits, it helps to understand exactly what a partnership business is.
Advantages and disadvantages of a partnership business
Understanding the pros and cons of forming a partnership business can better inform you about how a business partnership works and help you decide whether this is the most beneficial structure for your organization.
- Stronger financial position. The ability to pool resources can provide your business with more capital and access to new investors, while better positioning the company to borrow money. Sharing business expenses with your partners can help you save more than you might have on your own.
- Brain trust. Being able to share skills and institutional knowledge is a key benefit of a business partnership. This can help broaden your expertise and the versatility of your business.
- A broader network. By sharing contacts and connections with your business partners, you can develop new relationships and expand your professional network.
- Fresh eyes. Bringing in partners can provide new perspectives on how you do business by seeing things from a different angle. Partners can offer fresh ideas, market strategies and inspiration to grow your business.
- Tax savings. If your business is set up as a general partnership, your company may not need to pay income taxes. In Canada, a partnership by itself does not pay income tax on its operating results and does not file a tax return. Instead each partner includes a share of the partnership income or loss on a personal, corporate or trust income tax return.1
- Liability. The primary drawback of a partnership is that all partners share losses, debt and risk, and are fully liable for the financial obligations of the business. This means creditors can seize any partner's personal assets if these obligations are not met.
- Loss of full control. Sole proprietors who are used to doing everything their own way might be in for a bit of an adjustment when switching to a partnership business. Partners share decision-making and may need to compromise when they can't agree.
- Potential for conflict. Having more than one person making business decisions creates the potential for differences of opinion that can lead to conflict. Partners may also become bitter if they feel like one person isn't contributing his or her fair share.
- Difficult to sell. A partner cannot sell a business without the consent of all of the other partners, potentially creating a stalemate when one of the owners is ready to leave.
- Risk of instability. Without a plan in place, one partner's death, illness or withdrawal from the business may put the future of the company in jeopardy.
How to create a partnership business
Working with one or more partners can add complexity to setting up a business. Following certain steps can help simplify the process.
- Select a partnership structure. There are three different kinds of business partnerships:
- General partnerships. The most common partnership type. By definition, this consists of two or more individuals who share the business' profits and losses, as well as day-to-day decisions.
- Limited partnerships: Include both general and “silent" partners who are not involved in day-to-day decision making and have limited liabilities based on their financial contributions.
- Limited liability partnership (LLP): All general partners can receive liability protection.
- Choose partners and their roles. Find partners whom you trust, as this decision will set the tone and terms of your business. Decide how much it will cost to join the partnership, what percentage of the profits each partner will receive and which roles and responsibilities each partner will have. Some partners may contribute equity, or ownership share in the business, while others might be salaried partners who are paid as employees.
- Name your business. Your partnership's name will offer a first impression of your business. You may consider a name that accurately represents the purpose of your partnership business, or one that incorporates the names of your partners and any designations such as LLP. Remember to do some research to make sure the name you choose is unique so you don't fall prey to copyright violation.
- Register your partnership. In most parts of Canada, partnership businesses must register their names with the province in which they plan to operate. Registering will help make sure you are not using the same name as an existing business. You will also need proof of this registration to open a business bank account.
- Obtain a business identification number. Commercial partnerships in Canada need to obtain a nine-digit Business Number from the Canada Revenue Agency; this number also serves as the business Tax Identification Number (TIN). If you plan to do any business in the United States, you will also need to obtain an Employer Identification Number from the U.S. Internal Revenue Service (IRS).
- Create a partnership agreement. After you and your partners agree to their roles and responsibilities, get everything in writing. An attorney can help you draft a business partnership agreement form to detail provisions such as each partner's rights and duties, financial obligations, profit distribution, ownership, dispute resolution, confidentiality and an exit strategy.
- Secure necessary licenses and permits. Partnerships must comply with federal, provincial and municipal business laws and regulations. Local governments may require you to obtain a business permit or license to operate. You may also need specialty licenses to sell goods, such as alcohol, food or cigarettes, or to operate a specialized business such as an amusement park or transportation service. If your business will collect retail sales tax in Canada, you must register with your province to obtain a vendor's permit and follow the provincial tax remittance schedule. You may also need to register to collect the Goods and Services/Harmonized Sales Tax as a partnership and obtain a GST/HST number from the Canada Revenue Agency.
Business partnership agreement
A business partnership agreement is a written contract between partners that specifies their obligations and contributions to the business, as well as other conditions of their relationship. Every business partnership agreement form should detail these clauses:
- Who makes decisions Determine how you will make important decisions and what to do when partners disagree.
- Percentage of ownership. It's important to calculate and make clear how much of the business each partner owns. Also indicate how much money each contributed to join the business, and what should happen if the business needs more money to operate.
- Profits and losses. Set a formula for how partners will share earnings as well as losses.
- Exit strategies. Come up with contingency plans for what should happen if a partner dies, becomes disabled or wants to leave the company.
Does a partnership business make sense for your company?
Before you decide whether a partnership is the ideal business type for your organization, consult with an outside expert and carefully consider the following:
- Legal liability. How much liability is ownership willing to take on? If you are adequately insured and can afford to put your personal assets at risk, then the financial gains that a partnership can offer might be worth it.
- Taxes. Choosing a business type can depend on where you want the tax burden to fall. A partnership business itself does not pay taxes, meaning profits and deductions pass through to the individual partners, who then report these items on their personal income taxes.
- Long-term plans. Look ahead to what might happen to the business in the future. In a partnership business, it's important to consider who will take over the business after the founding partners are no longer involved.
- Costs. Although corporations offer strong liability protection, they require more extensive record-keeping and reporting, thus incurring higher administrative costs than other business entities. They are also the most expensive business type to form, making partnerships a more attractive option.
- Freedom. The business structure you choose can dictate how much flexibility, administrative responsibilities and decision-making power you will have. Corporations tend to be the most constricting in these areas. If you're looking for more freedom, less bureaucracy and the authority to call the shots, then a sole proprietorship might be the right choice for you.
This article is intended for general informational purposes only and does not constitute legal advice or an opinion on any issue. It should not be regarded as comprehensive or a substitute for professional advice.