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Know About the Four Types of Partnership Firm

The article discusses the salient features of different partnership models. Read this to know more about them in detail.

Running and managing a business is a complex affair. It requires multiple skills. Some may have the idea and vision and even the resources.  But they may lack other entrepreneurial skills. If different individuals with different skills decide to work together in harmony to achieve a common goal, the result is bound to be a success. And the fruits of this success can be shared among the people who joined hands to earn it.  If not so,  in the worst-case scenario, if the partnership firm fails, the risk will be distributed among the individuals who decided to work together for such a goal.

Thus,  a partnership can be defined as a complementary relationship between two or more individuals or entities who work together for a common goal. The choice of ownership, distribution of profits, allocation of roles and responsibilities, and sharing of risks and liabilities decide the nature of this partnership.  Therefore, the word partnership encapsulates a wide gamut of business relationships based on ownership, funding and roles and responsibilities, sharing of risks and returns, etc.

Types of Partnership Firm

In India, all partnership firms are governed following the Indian Partnership Act, 1932. A partnership firm can be formed based on a deed or contract, which needs to categorically mention the business’s terms and conditions and provide details regarding the sharing of profits, risks, etc., among the partners. The signing of such deeds between the partners officiates the establishment of the firm. It can then register itself with the Registrar of Firms. Such registration enables the partners of the partnership firm to enjoy certain rights mentioned in the partnership deed. Any violation of terms and conditions gives the partners the right to sue each other, or they may jointly decide to fight a legal battle against a third party that may appear to harm their firm’s interests.

Like most relationships, a partnership firm has multiple advantages and disadvantages; basically, the nature of the partnership dictates whether or not the benefits will outweigh the disadvantages. Thus, understanding different forms of partnership is the stepping stone for conducting a comparative analysis among them. By evaluating various pros and cons, the partners can decide which form of the partnership will serve their purpose and fetch maximum return.

General Partnership

In a General Partnership firm, two or more individuals may decide to run their business as co-owners. They may or may not have an equal share of the company. The ownership and profit sharing will be based on a partnership agreement signed before commencing such a partnership. The profits are counted as the individual income; thereby, in the case of General Partnership, businesses are not taxed separately for their profits. Instead, the partners pay the tax if they earn any profit income.

This type of partnership firm can be easily formed or dissolved. It is a low-cost and flexible form of partnership. In this form of partnership, the partners possess independent power for a business tie-up. However, each partner will have the total liability to bear the business debts and/or legal obligations. Thus, this can be a risky affair, mainly because the partners are liable for their actions and others’ actions. In short, this type of partnership model involves a lot of power and a great deal of mutual responsibility.

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Limited Partnership

Limited Partnership is a more formal and organised form of a partnership model than the General Partnership model. There has to be at least one general partner who will be responsible for managing the overall business for this partnership. They bear the liabilities of the business as well. On the other hand, these general partners are supported by one or more limited partners, who give the money to run the business but are not actively engaged in managing the day-to-day business.

Limited partners do not take part in the decision-making. They do not need to bear the risk or share the responsibilities of running the business. Especially the silent limited partners can enjoy the profits, and/or just in case the business runs into trouble; they risk losing the amount they have invested, but not more than that.  Thus, the Limited Partnership model offers legal protection to the limited partners to safeguard themselves from the liability of General Partners.  On the other hand, the General Partners can enjoy the overall control over the business. Entrusted by investors, they have the total responsibility to run the partnership firm and have the freedom of independent decision-making. However, they have the entire liability to bear the risks and debts.

Limited Liability Partnership (LLP)

A limited liability partnership (LLP) can be explained as a concoction of General Partnership and Limited Partnership. In this form of the partnership model, all the partners can actively manage the business. Still, they can safeguard themselves from taking responsibility and liability for the actions of other partners. They are only liable to take responsibility for their actions. Thus, one’s asset is not at risk even if the business runs the risk of loss or debts. In such a case, each business partner will lose the money they have invested in the partnership firm. Therefore, the risk is more distributed among the partners in this form of partnership, but the business can leverage individual skills and expertise.

This type of partnership firm is prevalent among professionals, like doctors, lawyers, or accountants, who put together their expertise and resources to run a partnership business. This typically reduces the individual cost of running the business while unleashing the possibility of sharing profits without taking too much individual risk. Another significant advantage of this type of partnership firm is that the partners of the LLP form business can quickly leave or join the partnership.

LLC partnership

A Limited Liability Company (LLC) operates as a business entity where owners are protected from taking any personal responsibility for the debts or liabilities of that partnership firm. LLC partnership can be between two or more owners known as members. It operates as a hybrid model, comprising the characteristics of a corporation and a partnership and/or sole proprietorship model of business.  The rules and regulations for LLCs vary from country to country. However, the salient feature of this type of corporate structure is that individual partners are exempted from the liabilities of bearing the company’s debt or other forms of legal obligations. LLC, as a partnership firm, LLC is not required to pay direct taxes on its profits. Instead, the partners sharing those profits are liable to pay tax on their income.

Conclusion

Understanding different partnership models are important to assess the risk and rewards of running a business as a partnership firm. During the inception of any partnership, the partners generally share a common vision and agreeable terms, but any business crisis can gravitate the partners towards doom. In that case, it is important to know the obligations while keeping in mind the escape routes. A thorough understanding of different forms of partnership models will help individuals to make the right decision at the right time.

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