Many people plan to start a business, but they are not doing it alone. They may have a friend, investor, or co-worker with whom they would like to start this business. Conversations may revolve around being business partners, but what does that really mean? Is a partnership business as simple as it sounds? What are the pros and cons of partnership business? Do you still need corporate governance documents and a rigid structure? Before beginning a partnership business, it is a good idea to try to answer these questions. If you have questions about getting into a partnership or other type of business structure, contact Harrison Law, PLLC at (480) 320-2310 and let our legal team help you determine what may be right for you.
What Are the Pros and Cons of Partnership?
Before getting into the pros and cons, it is important to understand that a partnership business does not necessarily mean that there are only two people. Partnerships can be more than two people.
At the federal level, there are three types of partnerships: general partnerships, limited partnerships (which Arizona breaks down into three more subtypes), and limited liability partnerships. Each type of partnership has additional, slightly different pros and cons to them, so before moving forward with a specific partnership type, potential business partners may wish to consider going over their options with an attorney and an accountant who can advise them on which partnership structure may best suit their business and individual goals.
Pros
A partnership business can offer many advantages, including:
- Spreading the burden of finances, paperwork, and other work
- Providing additional knowledge from a partner with different experience and information
- Reduced paperwork for registering than some other business forms, though the Arizona Secretary of State does require paperwork for some partnerships
- Relatively few tax forms compared to some other business structures
- Allowing more time to pursue other opportunities with the business, such as exploring new marketing methods or rebranding, compared to some other forms of business
- Ease of maintenance due to the flexible structure compared to corporations
- Lower friction in the decision-making process compared to corporations
- Expanded network and audience compared to sole proprietorship, particularly if one or more partners can demonstrate extensive experience or leverage an established professional reputation
- Ease of sale when any partner is ready, relative to corporate business structures
Cons
While there are many benefits to a partnership, a partnership business may also carry disadvantages, such as:
- Partners must make decisions together, which can be a problem if they prefer to make decisions independently or cannot agree.
- Partners must split profits, which can be difficult if the business is operating with a narrow margin, or if one partner feels another is not doing their share of the work.
- All partners are legally and financially responsible in some types of partnerships, which can put their personal assets at risk if the business incurs debts or lawsuits.
- Partners must pay individual instead of business taxes, which typically means a higher tax rate than that paid by corporations.
- If there is no exit strategy, or if the contract is unclear, it may be difficult for a partner to withdraw from the business.
- Partners may come into personal conflict if business values are not aligned or if contributions to the business are perceived to be unequal.
- The informal arrangement that provides flexibility can also pose a challenge if the distribution of responsibilities is unclear.
- Without an exit strategy or a clear plan, partnership can easily collapse if one partner leaves or dies.
What Is the Purpose of a Corporate Governance Document?
Corporate governance documents can include bylaws, shareholder agreements, articles of incorporation and other documents. These documents may seem like inconsequential formalities, but they can be very beneficial to running a business. Corporate governance documents create a system of rules, practices, and policies that can determine how a company operates and how it aligns with its stakeholders’ interests. This can help with creating ethical business practices which can support financial viability, which in turn attracts investors.
Another benefit of these documents is that they can make clear to employees, vendors, customers, and investors how the company operates. With these documents in hand, everyone understands how things should be done, so that partners are not providing different information to different people and causing confusion. The importance of corporate governance is not reduced when the business is a partnership. Harrison Law, PLLC may be able to help you create your corporate governance documents.
What Are the Pros and Cons of Incorporation As a Form of Business Organization?
A corporation is a business that the state recognizes as a legal entity separate from the individuals who own it. Like the pros and cons of partnership business, corporations also have pros and cons that should be considered.
Pros
Some of the advantages of a corporation can include:
- Personal liability protection, as the owners’ personal assets cannot be taken for business debts or lawsuits
- Business security and perpetuity because participation in a corporation is based on stock ownership, which makes transferring ownership easy
- Ready access to capital through sales of equity in the company
- Tax benefits, such as spreading out tax losses
- Easy ownership transfer, which can be attractive to both investors and employees
- A clear structure with a board of directors, management, and other roles well-defined
- Stock and stock options for employees
- The right to due process and equal protection of the laws, as the corporation functions for many legal purposes as a distinct “person”
Cons
Corporations also present drawbacks, which may include:
- A sometimes lengthy application process, although the Arizona Corporation Commission only requires a three-page Articles of Incorporation filing
- Rigid formalities, protocols and structure that must be followed including government rules regarding shareholder and board of directors’ meetings, maintaining financial independence, and records of corporate activities
- Possible double taxation when the Internal Revenue Service taxes the profits when earned and again when distributed to shareholders
- High costs required to form and operate
- More complicated than a sole proprietorship or partnership business
- No right to a court appointed attorney or Fifth Amendment protection against self-incrimination in court
- Reduced individual control over the business compared to a partnership or sole proprietorship
What To Consider Before Starting a Partnership
Considering the pros and cons of partnership business is an important step to deciding whether to start a partnership. However, there are other things that should be considered before making a final determination as to business structure. A few points to bear in mind might include:
- Making sure all potential partners share similar values to reduce conflict and promote business success
- Setting clear expectations about what each potential partner is expected to do from the start
- Outlining how to manage the business finances, including how the profits will be split
- Deciding on a partnership type
- Determining how to handle the partnership’s dissolution if one or more partners wishes to leave or dies
The importance of corporate governance in a partnership cannot be overstated, as these documents ensure everyone shares the same business ethics and agrees on how to operate the business. For these reasons, individuals considering any form of business partnership may wish to consider having an attorney draw up legal documents, including a partnership agreement and corporate governance documents.
Are You Considering a Partnership Business?
After weighing the pros and cons of partnership business, you may feel confident in your decision, or you may still have questions. Whether you are ready to move forward with the appropriate paperwork or want to get answers to lingering questions, Harrison Law, PLLC may be able to help. Call us at (480) 320-2310 and let one of our experienced attorneys go over your options with you.
© 2023 Matthew W. Harrison and Harrison Law, PLLC All Rights Reserved
This website and article have been prepared by Harrison Law, PLLC for informational purposes only and does not, and is not intended to, constitute legal or financial advice. The information is not provided in the course of an attorney-client relationship and is not intended to substitute for legal advice from an attorney licensed in your jurisdiction.
