This article explains the definition of sole proprietorship and partnership business structure and the key differences between them.
Definition of Partnership
Partnership is a business owned, operated and managed by two or more parties agreeing to share the profits and losses from the business.
Features of Partnership
- Partnership is an unincorporated business structure i.e. partnership is not a separate legal entity from its partners
- Partners can be individuals, company i.e. partnership can exist between two companies
- Partners contribute to the business in many ways such as capital, labor, skill, property etc.
- Partnership profit and losses are shared among the partners depending on the percentage of sharing as agreed by the partners.
- Partners pay the taxes on the basis of their share in the profit and losses
- Types of Partnership are general partnerships; limited partnerships; and limited liability partnerships.
- Partners’ liability depends on the type of the partnership.
How to Form a Partnership?
To form a partnership:
- Sign a Partnership Agreement
- Register your partnership and open business account, as required by the local state laws.
- Start Your Business
Key terms to include in a partnership agreement:
- Partnership capital contribution
- Profits and losses allocation percentages
- Partnership Board Establishment, Powers and Responsibilities
- Partnership Property Management Provisions
- Partner Undertakings
- Accounts and expenses management
- Termination provisions
- Dispute Resolution provisions
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Types of Partnership
a) General Partnership
Description: Partners share equal responsibility for the manage of business and liabilities (e.g. debt)
Partner’s Liability: Unlimited personal liability
b) Limited Partnership
Description: Comprises one or more general partners and the others are limited partners.
Liability:
- General Partners have unlimited liability and generally manage the business operations
- Limited Partners liability is limited the their funding/investment in the business. They generally do not manage the business operations
Example: Business has a general partner who manages the project and a limited partner providing the funds/ capital.
c) Limited Liability Partnership
Description: All partners share equal responsibility but have limited liability protection. They are more popularly known as LLP’s
Liability: Liability is limited i.e. partners are not personally liable for negligence of other partners
Key Fact about LLPS: Limited liability partnerships are special partnerships that are permitted for certain professions only such as lawyers and accountants.
Definition of Sole Proprietorship
Business is owned and managed by one individual in sole proprietorship. However, the proprietor of the business can engage more employees.
This is an unincorporated business and the decisions are taken by one individual who is personally liable for the liabilities.
Features of Sole Proprietorship
- Owned and operated by one individual
- Owner is personally liable for all liabilities and it is not a separate legal entity
- Owners also get all profits from the business operation
- Simplest way to start a business
- Less administrative paperwork than other business structures
- Owner has complete control over the business operation
- Sole proprietor has an unlimited liability i.e. the sole proprietor could lose the income generated from the business, business assets as well as the personal assets to pay off the business debt
- In case of bankruptcy, creditors can sue the proprietor and claim can be made against the personal assets of the proprietor
- Business cannot continue in the event of illness, incapacitation or even death of the owner) unless transferred to heirs or sold.
- Freelancers, small businesses and consultants prefer this structure over other types of business structures because of low start-up costs
How to Form A Sole Proprietorship?
Sole Proprietorship is the simplest way to start a business. To form a sole proprietorship:
- Check business registration requirements under the applicable state laws
- Open Business bank account, if required under local laws
- Start your Business
Sole Proprietorship Vs. Partnership: A Comparison
What are the advantages and disadvantages of a Sole Proprietorship?
Advantages of a Sole Proprietorship
The advantages of a Sole Proprietorship include:
- Complete Control: Owner has complete control over all business operations and decision making
- No Profit sharing: Owner gets all the profits from the business
- Easy to Establish: Simplest way to establish a business as minimal paperwork and costs
- Tax: Income is taxed as personal income
Disadvantages of a Sole Proprietorship
The disadvantages of a Sole Proprietorship include:
- Personal Liability: Unlimited liability for sole proprietors means that the proprietor is not a separate legal entity and can be personally liable for all debts and liabilities.
- Limited Resources: Limited financial resources and raising capital will not be easy
- Continuity: Business ceases with the owner’s death, retirement or the owner becomes incapacitated
- Limited Expertise: Limited expertise and knowledge
What are the advantages and disadvantages of a Partnership?
Advantages of a Partnership
The advantages of a Partnership include:
- Tax: Partners are taxed individually depending on their tax rate and share and not like separate entities
- Decision Making: Shared decision making amongst the partners which also implies that responsibility is also equally shared.
- Easy to Establish: It only requires a partnership agreement to establish a partnership
- More resources and skills: Partners bring different skills and expertise to business
- Dissolution: Partnerships can be dissolved depending on the terms agreed
- Continuity: Business can continue to operate despite the death or incapacity of a partner depending on the terms of partnership
Disadvantages of Partnership
- Profit Sharing: Profits from the business are shared between the partners regardless of contribution
- Taxation: Can lead to higher tax bracket for the partners individually depending on income bracket
- Unlimited liability: General partners liability is unlimited i.e. personally liable for debts etc.
- Less Autonomy: Partners must collaborate over day to day operations. Individually they lack less control over the business.
- Disagreement and Disputes: Disagreements between partners can lead to dispute and adversely affect the business growth.
- Unreliable Partner: Unreliable partner can put the business at risk
How to choose between Sole Proprietorship and Partnership
Sole Proprietorship suits for:
- Freelancers or Independent Contractors
- Small Businesses with low risk
- Individually owned business
- Business with Low- startup capital
Sole Proprietorship is the right choice if the following key factors are applicable to your business:
- You want to take all the decisions independently
- You want to keep all the profits
- You are running a business with low risk
Partnership suits for:
- Restaurants, Consulting Firm, Law Firm, Private Tutoring Centre etc.
- Businesses that need more capital and expertise for growth and expansion
Partnership is the right choice if the following key factors are applicable to your business:
- You are willing to collaborate and share responsibilities with other individuals
- You are willing to share the profits and losses with other individuals
- You want to share the decision making process
- You need additional capital and expertise from other individuals
- You need expertise and varied skills for your business growth
Please note that this is a guide on the general position of different types of legal entities under common law. This does not constitute legal advice. As each jurisdiction may be different, you may want to speak to your local lawyer.
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