When you enter into a business partnership, it’s essential that you understand both the advantages and disadvantages of doing so. Partnerships can be very simple business agreements, but they do have disadvantages associated with them. Because the relationship is very informal, it may not have the same protection for both parties involved. Unclear rules, liability limits and difficulty transferring ownership are just a few examples of the disadvantages business partnerships can face.
Before entering into a business agreement with a partner, entrepreneurs should be prepared for potential risks and problems in the future. These risks can be minimized with the right agreement or the forming of a corporation between the two parties. A successful, profitable business can go downhill very quickly if both partners are not on board with the same ideas and goals.
Vague Authority Limits
One major disadvantage associated with a business partnership is the vague, unclear authority regarding each partner’s responsibilities to both those within the partnership and those on the outside. In a traditional partnership, both partners have equal authority and equal stake, with no hierarchy regarding who is in charge. Outside parties assume that both partners will act for the partnership. This leaves the chance that one partner may make a choice for another that is not in the best interest of the business. One partner may enter into an unwanted agreement with a third party, binding the other partner to the same agreement without authority.
Lack of Stability
If one partner chooses to retire, quit, or resign, then the business automatically dissolves. This can also happen if one partner dies suddenly or has to file for bankruptcy. For the remaining partner, this means a fast end to a profitable business that he or she has spent time and energy building. This lack of stability is not present in such business partnerships like a corporation, where there is order to end the existence of the business. With a partnership between two people or parties, there is a lack of stability involved in the future of the business.
If a partnership is formed between two individuals, then both are responsible for the business, meaning if there are any unresolved debts, personal assets may be at stake in an equal manner. While this problem can be solved when both partners form their own corporation and join as one business, the liability falls to both individuals in an informal partnership. That means both partners have unlimited liability when it comes to the business and its debts, and both may face the loss of personal funds in order to resolve debts.
When a partnership is formed between two corporations, the liability is limited to the business, rather than extended to personal assets and funds.
Lack of Flexibility in Transferring Ownership
As a general rule, if no agreement is made to change the process, then both partners must be in agreement and give prior consent any time a partner’s stake is transferred. If the partners have some type of disagreement regarding the transfer, then the partnership is left in limbo and cannot be transferred. While the partnership may start out with both parties agreeable and committed, the reality is that opinions and desires change once a business is profitable, and transferring ownership becomes very difficult without a formal agreement written beforehand.
Is a Partnership the Right Way?
Even the most profitable business can end up in trouble if the right precautions are not taken to protect both partners in the event that a disagreement, death or bankruptcy happens. Even with certain limitations, partnerships offer an informality and flexibility that many small businesses benefit from. The limitations associated with an informal partnership can also be avoided when a partnership agreement is signed before the company is formed or when the business becomes a limited liability company.
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