Choosing a Business Model: U.S. Partnership

What is a Partnership Agreement?, most people have an idea but they do not know the in's and out's and most especially the risks involved. A U.S. Partnership is a working relationship that is created between two or more people to make a profitable enterprise that shares management and financial responsibilities, knowledge, skills and effort from labor. The partners share risks and benefits from the profits and losses of the business.

Some people operate their partnership agreement without having a formal agreement and others base their agreement on a verbal, oral understanding between each member. This is not a good route to take because of the risks and liabilities that each partner has in the business and when the enterprise gets into difficulties damaging arguments often arise about who is going to be responsible and that usually involves losing money and time.

Two commonly believed myths that constitute a U.S. Partnership:

(a) A simple agreement to share expenses either verbal or written.

(b) Joint ownership of property or equipment that is being leased or rented.

Neither scenarios are recognized as a partnership agreements.

A legally binding partnership that avoids violating tax laws and regulations comprises the following considerations:

(a) Each partners' behavior in fulfilling the provisions of the agreement.

(b) The relationship between the members; are the members friends and family or strictly business contacts?.

(c) Are the strengths and weaknesses or abilities and potential contributions of each member complimenting or is there a shortfall in the members strengths to run a successful enterprise that will survive economic difficulties?.

(d) Defining each members control and purpose over income and expenditure.

Disadvantages of forming a U.S. Partnership

People who set-up and work within the framework of a business partnership model frequently end their involvement in the enterprise through conflict and disagreements despite having originally laid-out the rights, duties and responsibilities of each member in a Partnership Agreement. The main reasons for this can be traced to the lack of definition about each persons role and authority in the business and the lack of a clearly identifiable CEO that is so evident in the pyramid structure of the LLC and Corporation. To some extent those problems can be resolved by using a comprehensive partnership agreement package but considerable planning and discussion is needed to circumvent the possibility of future conflicts at best and liquidation of personal assets at worst.

The feasible financial liability that could arise from a partnership if the business failed is potentially far greater and risky than that of a Sole Proprietorship and this is because each partner member attracts unlimited personal liability from creditors debts of the business. A possible scenario is that a partner goes on a spending spree or makes unwise decisions and ramps-up debt causing the other partners to become encumbered with debt that cannot be paid from the assets of the enterprise. Then the creditors are allowed to target the partners personal assets. Therefore each partner does not have full or direct control over the business assets or personal assets that can be lost or damaged through the actions of a partner, creating a high risk unsecured personal lose situation.

It may be further stated that an individual partner carries all the liabilities of the partnership irrespective of who was originally responsible for destructive or irresponsible practices.

Other personal liability and business risks can also include cases of employee negligence if an event of negligence happens during the normal course of business within the partnership. Then each partner may be encumbered with the personal liability of compensation if the business lacks the funds. As with the risks identified with control of expenditure the risks are further amplified because of the liability carried by an individual partner that may be compromised through the actions and activities of the other partner(s).

The partnership has a common similarity to the sole proprietorship model because it lacks continuity of purpose and longevity because it is closed or liquidated if a fellow partner dies.

In this situation the business has to be audited and final accounts have to be published prior to dividing and selling-off the assets to settle debts of the business on behalf of the members heirs.

This situation can only be avoided if special instructions and arrangements have been made that anticipate and are written into the original partnership agreement.

A further disadvantage of a partnership business model is it's inherent difficulty to raise finance either through the stock market or from banks and a further difficulty is that pension and profit sharing arrangements are not available benefits unlike corporations.

Advantages of a U.S. Partnership Business Model.

In a Partnership if each member has personal collateral then by combining those resources to obtain business credit the potential to raise cash for investment in a business is for many greatly enhanced when compared to the borrowing potential of most sole proprietorship’s. But the borrowing potential of a corporation far exceeds either of the two former models.

Income generated from a partnership business is paid directly to each partner and is normally taxed at personal income tax rates excepting if one partner is being taxed at a different rate then each partners tax affairs or rate is affected. This is a distinct advantage when compared to a corporation which pays double tax when profits are shared as shareholders dividends.

For most people who wish to simply work or share work together and the associated profits the partnership is often chosen because of it's simplicity of structure and purpose and similarity to the sole proprietorship model. The start-up costs are low and the model has very little legal regulation unlike an LLC. But the simplicity is also deceiving because of the lack of inherent structure through which is realized the duties, responsibilities and scope of each partners various authorities and status; from this frequently emulates disagreements, arguments and ultimately termination of the partnership.

For clarity to prevail in a partnership business model about the rights, responsibilities and tax circumstance of each partner it makes good business sense to start-off with a formal Partnership Agreement. Because each U.S. State has adopted the Uniform Partnership Act which has outlined in it partnership laws providing a clearer understanding at the beginning of the working relationship with a formal written agreement to avoid future problems.

It may be said that the Partnership has many similarities to a Sole Proprietorship and for this reason it may be safer for each person to register as a sole trader and to create back-to-back Joint Venture agreement to circumvent the collective personal liability scenarios of forming a partnership. But the worlds most successful partnership was in Britain; the John Lewis Group became a great success because it is a Private Limited Partnership having the advantages of a limited liability company without having to publish it's annual accounts. This model is no longer available in the UK but it is available and not widely used in the U.S., it provides the best compromise solution in the Partnership Business Model.

If the partnership model is planned to have a limited life-time, before migrating the business model to a safer haven, so as to prove that an innovation and associated market idea is viable whilst testing and exploring the market conditions to save the set-up costs of an LLC or Corporation. Then in that circumstance of a long term strategy of eventually limiting personal liability by creating an LLC or Corporation, It may be considered a useful proposition providing none of the partners do not already carry unwieldy personal financial and/or tax burdens or liabilities;which might express itself in the form of bankruptcy, divorce or health issues.