There is very little practical day-to-day difference if a very small family business is operated as a sole proprietorship or as a limited company with perhaps just two shareholders (often a wife and husband or two other closely related people) who are both directors. Strictly the
similarity is closer to a partnership, but often there is one person who is the driving force in the enterprise with the other helping. The only real advantage of forming a company or sometimes buying a dormant company and getting it going again is to gain the protection of limited liability. This is a valuable protection if the enterprise runs the risk of failing with substantial debts, but for many service organisations such a risk is very small and there is no need to incur the formality and expense of a limited company.
D. PARTNERSHIPS
Some of the disadvantages of the sole trader can be overcome by forming a partnership. This increases the financial resources and widens the range of expertise available to the firm.
The legal definition of a partnership was put forward in the Partnership Act 1890 and is as follows:
"The relation which subsists between persons carrying on a business in common with a view of profit".
So a partnership refers to people coming together to pursue common business goals. Two or more persons carrying on a business together constitute a partnership. It does not require any formal, written agreement; a verbal arrangement is sufficient.
In the UK, the Partnership Act 1890 limits the number of partners in a business to twenty, with some minor exceptions (including qualified and practising accountants and solicitors and the business members of a recognised stock exchange).
Partnerships flourish in the same areas as sole traders. They appeal especially to
professional people, who can retain a lot of individual freedom of action and maintain their personal relationship with clients while gaining the advantages of larger amounts of capital and of expertise.
Partnerships are usually regulated by an agreement which covers the terms for subscribing capital, the division of profits and losses, duties, salaries and the procedures for dissolving the partnership. It is very unwise to carry on business without such an agreement.
There is, then, likely to be a formal, written partnership agreement or deed of partnership. However, a partnership may be deemed to exist by implication from the behaviour of the parties concerned – for example, if a person shares in the profits (and losses) of a business, that person may be deemed to be a partner. The existence of a formal deed avoids disputes on how work and profits are to be divided. Such an agreement will also make clear the date of the commencement of the partnership and, if it is to exist for a fixed period, the date on which it is to end. If it is not for a fixed period, there should be agreement on what will happen on the retirement or death of a partner. Further, unless there are procedures set down for operating and dissolving the partnership, the individual members can suddenly be faced by all the financial difficulties caused by unlimited liability for all the debts of the partnership.
The key features of a partnership are:
All partners have unlimited liability for the debts of the firm, just as sole traders do, so a partner could lose his/her personal wealth if the business folds. This very heavy liability for the whole of a firm's debts applies to each partner no matter what agreement the partners may have made between themselves for sharing losses. Thus, one partner could be in a position of losing everything, if the other partners do not have sufficient assets, even though the losses may have been caused entirely by one of those unable to pay. It is not difficult to see why a limited company structure is likely to be preferable if there is any risk of substantial financial losses.
(Note that the existence of limited liability partnerships changes this, and we consider this form of organisation a little later.)
Any partner can bind the partnership to a contract with third parties.
All partners are jointly liable for meeting the obligations of contracts on behalf of the partnership. The partners usually have joint and several liability, which means someone could take legal action against the partners jointly or against each partner
individually – for example, in a claim for damages due to negligent performance of the partnership's obligations under a contract.
A partnership, like a sole proprietorship, is not a separate legal entity like a limited company, so it is the partners who are personally liable.
All partners share profits according to agreed arrangements.
The name of each partner and the business address(es) must be shown clearly on all business documents and full names of partners must be displayed at the place of business.
Advantages and Disadvantages
The advantages of partnerships stem from the fact that their organisational structure lies between that of a sole proprietor and a company, so that in a sense they can obtain the best of both worlds.
Like the sole proprietor and the very small limited company, they are small enough to be flexible and the partners are close enough to the "grass roots" of the business to know what is going on. The principle of professional accountability to clients and customers is retained.
The legal and financial procedures are relatively simple – for example, the accounts of the business need only be prepared for the information of the partners and for the calculation of tax liabilities. There is no obligation to publish accounts.
There can be division of labour between the partners so that each can specialise and benefit from each other's expertise in the running of the business. Such working arrangements are based on trust and mutual confidence between partners.
Partnerships need not be too bureaucratic, and systems and controls in the enterprise need not be too complex.
Partners may cultivate a degree of interchangeability so that if one is ill or away from the business, other partners can take over the work.
While operating as individuals, the partners can share the cost of common premises, staff and services, as in the cases of doctors, dentists and solicitors.
It is easier for partnerships to raise extra resources in order to expand or develop – unlike the sole proprietor, the partnership is likely to have more assets to use as security for loans. A partnership can also raise more capital by adding new partners. The main disadvantages of partnerships derive from shared ownership and control of the enterprise.
Partners have unlimited liability – financial failure of the partnership can spell personal financial ruin for the partners.
The withdrawal or death of a partner may dissolve the firm. Any partner can enter into an agreement which binds the others.
Decision making may be difficult and slow as all the partners have to agree – one difficult partner could create problems.
For a variety of reasons partnerships are not as stable as sole trader firms. Shared control means the possibilities of disagreements and delays. Partners are human beings with human feelings; some partners may be dishonest, some may be lazy or there may be clashes of personality.