Forming a Partnership verus a sole proprietor or Corporation


The second legal business form is known as a partnership. As you might suspect, a partnership is a legal business entity that has two or more owners. Similar to a sole proprietorship, a partnership's business name must be registered at your state/provincial government office, unless the business name consists of each partner's name (applies in most jurisdictions). The cost to register a partnership hovers between $100 - $200 (accounting & legal fees not included).

General background information on the partners may also be required to ensure that the partnership does not develop a tendency to act against public interest or safety. Such information is a means of deterring the partnership from acting unethically.

A partnership tends to work well for individuals with mutual goals, but with different resources and knowledge. Each partner is a co-owner of the business and is entitled to "share" a portion of the profits and losses. The sharing of profits and losses depend on several factors and as a result each partner should consult an accountant and/or a lawyer. These professionals will advise the owners to develop a Partnership Agreement. A Partnership Agreement generally details issues such as; a description of the rights, interests, and responsibilities of each partner. Other issues considered under a partnership agreement may include;

  • the amount and type of capital each will contribute to the business;
  • the division of profits and losses;
  • the extent to which profits and losses will be reinvested into the business;
  • the point in time when profits will no longer be reinvested;
  • the amount each partner can withdraw from the company;
  • the procedure for the death, termination, illness, retirement of a partner;
  • will additional partners be added and if so, what criteria must be met;
  • the procedure for financial accounting and record keeping;
  • the management role and authority of each partner with regard to decision making and resolution of disputes;
  • And so on...

In a nutshell, if a partnership agreement is not developed, then the partnership may ultimately be governed by the Partnership Act. The Partnership Act was developed by the government and may not be appropriate for your particular partnership (chances are it won't ).

A partnership can be dissolved at any time, and is automatically dissolved upon the death of any one owner; unless otherwise stated in the Partnership Agreement. Each owner MUST accept all responsibilities and assume all risks. Furthermore, each owner is personally responsible for all debts incurred by the business and, in many cases, is responsible for any wrongdoings of employees. Any business contract or dealing made by one partner automatically becomes legally binding by all partners of the company. In effect, each partner is responsible for the mistakes or discretions of every other partner.

There is no distinction between the assets of the business and the owners of a partnership. Moreover, if the partnership (the business) cannot pay its bills, creditors can sue the owners and take claim of their personal assets. In other words, each partner has unlimited liability; beyond the extent of his/her personal investment into the partnership.

Owners of a partnership, like a sole proprietorship, periodically "DRAW" (withdrawal) cash from their company to pay for personal living expenses. These monies are referred to as drawings. Many owners of partnerships consider drawings to be a salary. From a legal stand point, however, a cash drawing is not and should not be considered a salary of the partners. The reason is simple; owners of a partnership CANNOT enter into a legal binding contract with themselves and therefore, CANNOT hire & pay themselves a salary. In order words, if owners of a partnership plans to receive money from their company, they will receive it through drawings; not salaries.

Accounting for a drawing and a salary has accounting implication. Furthermore, a salary is considered an expense of the business and therefore, reduces taxable income (thus reducing the tax obligation). A drawing, on the other hand, is NOT an expense and therefore, it does NOT reduce taxable income. Moreover, as discussed under the equity section of the Balance Sheet, a drawing reduces an owner's capital (ownership) in his/her company.

Partnership (business) earnings accrue to each owner while losses can be written off against each partner's sources of income as outlined in their Partnership Agreement.

Categories: General