Financing General Partnerships
A general partnership is an association of two or more parties to operate a business for profit. The partners raise equity funds through their own capital contributions, by adding a new partner, or by restructuring the relative ownership interests of the existing partners to reflect new contributions. Debt financing for general partnerships is similar to financing for sole proprietorships, because the individual creditworthiness of the owners largely determines the business's creditworthiness.
Advantages of a partnership include:
- Inexpensive and simple to form and maintain: partnerships can be relatively cheap and easy to form and maintain. All partnerships should adopt a written partnership agreement, but there is no legal requirement for a contract. No statutory formalities are required nor are there any fees. However, if you choose to do business under an assumed name, registration with state authorities may be required.
- Favorable tax treatment: partners are taxed as individuals, and the partnership itself is not taxed. Each individual partner shares the income and deductions of the business according to the agreed-upon allocation of partnership interests. Because new small businesses frequently experience temporary losses, the pass-through tax treatment of a partnership can often benefit a partner by allowing the partner to immediately apply any losses from the business to offset income from other sources.
- Sharing of expertise and risk: partnerships are often formed to take advantage of the different skills and expertise of different persons. In addition, the partners also agree to share the financial and legal risks of the business, thereby spreading the cost of possible losses.
Disadvantages of a partnership include:
- Personal liability: a general partner has unlimited personal liability for business liabilities. Each partner bears personal financial liability for the contract and tort debts of the business. However, this financial exposure can be minimized, to some extent, by purchasing liability insurance.
- Limited transferability of ownership: most partnership arrangements restrict a partner's rights to withdraw from the partnership or to transfer the ownership interests.
- Limited financing options: obtaining financing, especially long-term financing, is often difficult for smaller partnerships. New equity financing is generally limited to increased contributions from existing partners in exchange for a greater ownership percentage, or by adding a new partner, which ordinarily requires the unanimous approval of all existing partners. Debt financing is easier than in a sole proprietorship, but may still be difficult because the business's credit is no better than the credit of each individual partner.
For more information on partnerships and partnership agreements, see our discussion of establishing a general partnership.
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