Setting up and running a business is a tough job. It involves significant challenges and hurdles that need to be crossed to stabilize a business. A business can be run in two ways: as a sole proprietorship or as a partnership. Both have their pros and cons.
A sole proprietorship is when a single entity runs the business and can enjoy all the profits. Also, this entity alone endures the losses as well. Running a business this way can seem incredibly beneficial but has some significant disadvantages. The owner is the only one responsible for the liabilities of the company; in case a business fails to pay off the debt, the creditors have the potential to seize their assets. It is also exceedingly difficult to attract investors and raise capital; when the owner dies, a business fails. Due to these reasons, many people consider running a business under a partnership to avoid these problems, but even a business partnership has flaws!
There are different types of partnerships, such as general, limited, and limited liability, each with advantages and disadvantages. As this article covers the burdens of a business partnership, the cons of each have been highlighted!
General Partnerships
General partnerships provide equal rights and responsibilities to all partners. Each partner has the right to act on behalf of the whole business.
Ambiguous Authority
A disadvantage of a business partnership is that the authority limits are vague and unclear. Even though the responsibilities are divided among the partners on the outside, both partners seem to have authority. It can lead to situations where one partner may sign an agreement, and the other must live by it even if they do not want to. When two partners disagree on a common thing, it gives rise to arguments and instability in a business.
Risks of Instability
With a business partnership, high risks of instability get attached to a business. If one partner files for bankruptcy or dies, the company becomes unstable, resulting in dissolution. The case worsens if a profitable business suddenly shuts down because a partner has retired, quit, died, or filed for bankruptcy.
Lack of Flexibility
When there is no agreement about transferability, the default rule is that without the consent of all other partners, a person’s stake is not transferable. It is a significant hurdle in achieving transferability. Also, if partners argue over the transferability issue, the process stops.
Risks of Management Disputes
Management disputes are bound to occur without a written agreement regarding which partner will oversee what aspect of a business. A general, unstructured partnership is more likely to end up in chaos. It is not an issue in a limited partnership but something that must not be overlooked in general partnerships.
Taxation Problems
Even though a business gets subjected to income tax benefits with partnerships, some serious taxation issues emerge. Each partner must pay tax like sole traders by submitting a yearly self-assessment. It can get worse if the business is very profitable, as higher taxes are imposed on people if it generates more than a specific number of profits.
Shared profits
When a business runs under a partnership, the losses must be endured by all the partners, which reduces the impact of losses. In the case of profits, even though profit must be shared among the partners. It can be a problem for people who put in more effort than other partners and do not receive the deserved outcomes. Without much effort, partners can benefit from one partner’s hard work.
Limited Partnerships
It is a type of partnership that is like the general type in many aspects. The difference lies in the fact that in a limited partnership, there must be at least one general and at least one limited partner, which plays the role of a silent partner.
Termination of Partnership
One of the significant threats to a business in a limited partnership is that when one of the partners dies or retires, the partnership is terminated. It makes a company unstable and can lead to a business shutting down.
Excessive Taxation
When a business is run under a limited partnership, the chances of excessive taxation are high. Only a little can be done to save a company from excessive taxation if it is run under a limited partnership.
Unprotected Assets of a General Partner
The general partner remains under threat as their assets are unprotected. If a business fails to repay the business debt, the general partner’s assets can be sold by a creditor.
Limited Liability Partnership
Limited Liability Partnership or LLP combines a partnership and a corporation. In such a partnership, no other partners are held accountable for the actions of other partners. The share is decided, and an agreement is signed, which helps in the smooth running of a business, but even this type has some disadvantages.
Complexity and High Taxation
The formation of LLPs is complex, so many states do not allow the formation of such companies. The conditions will enable the building to impose heavy taxes, making it difficult for a business to run smoothly.
Legal Recognition
Many states do not recognize these types of businesses as legal entities and self-employment taxes are imposed on the partners. Also, these types of companies are not given the same credibility as the other businesses.
Reviewing each partnership type’s cons is best before setting up a business under a partnership. Until or unless a plan is drawn up for how each of the legal matters will be handled, a partnership must not be chosen. It reduces the risks of a business getting dissolved or completely chaotic!
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