Partnership Firms:
Definition, Features, Advantages and Disadvantages
Definition:
The proprietorship form of ownership suffers from certain limitations such as limited resources, limited skill and unlimited liability. Expansion in business requires more capital and managerial skills and also involves more risk. A proprietor finds him unable to fulfill these requirements. This call for more persons come together, with different edges and start business. For example, a person who lacks managerial skills but may have capital.
Another person who is a good manager but may not have capital. When these persons come together, pool their capital and skills and organise a business, it is called partnership. Partnership grows essentially because of the limitations or disadvantages of proprietorship.
Let us consider a few definitions on partnership:
The Indian Partnership Act, 1932, Section 4, defined partnership as “the relation between persons who have agreed to share the profits of business carried on by all or any of them acting for all”. The Uniform Partnership Act of the USA defined a partnership “as an association of two or more persons to carry on as co-owners a business for profit”.
According to J. L. Hanson, “a partnership is a form of business organisation in which two or more persons up to a maximum of twenty join together to undertake some form of business activity”. Now, we can define partnership as an association of two or more persons who have agreed to share the profits of a business which they run together. This business may be carried on by all or anyone of them acting for all.
The persons who own the partnership business are individually called ‘partners’ and collectively they are called as ‘firm’ or ‘partnership firm’. The name under which partnership business is carried on is called ‘Firm Name’. In a way, the firm is nothing but an abbreviation for partners.
Main Features:
Based on the above definitions, we can now list the main features of partnership form of business ownership/organization in a more orderly manner as follows:
1. More Persons:
As against proprietorship, there should be at least two persons subject to a maximum of ten persons for banking business and twenty for non-banking business to form a partnership firm.
2. Profit and Loss Sharing:
There is an agreement among the partners to share the profits earned and losses incurred in partnership business.
3. Contractual Relationship:
Partnership is formed by an agreement-oral or written-among the partners.
4. Existence of Lawful Business:
Partnership is formed to carry on some lawful business and share its profits or losses. If the purpose is to carry some charitable works, for example, it is not regarded as partnership.
5. Utmost Good Faith and Honesty:
A partnership business solely rests on utmost good faith and trust among the partners.
6. Unlimited Liability:
Like proprietorship, each partner has unlimited liability in the firm. This means that if the assets of the partnership firm fall short to meet the firm’s obligations, the partners’ private assets will also be used for the purpose.
7. Restrictions on Transfer of Share:
No partner can transfer his share to any outside person without seeking the consent of all other partners.
8. Principal-Agent Relationship:
The partnership firm may be carried on by all partners or any of them acting for all. While dealing with firm’s transactions, each partner is entitled to represent the firm and other partners. In this way, a partner is an agent of the firm and of the other partners.
Advantages:
As an ownership form of business, partnership offers the following advantages:
1. Easy Formation:
Partnership is a contractual agreement between the partners to run an enterprise. Hence, it is relatively ease to form. Legal formalities associated with formation are minimal. Though, the registration of a partnership is desirable, but not obligatory.
2. More Capital Available:
We have just seen that sole proprietorship suffers from the limitation of limited funds. Partnership overcomes this problem, to a great extent, because now there are more than one person who provide funds to the enterprise. It also increases the borrowing capacity of the firm. Moreover, the lending institutions also perceive less risk in granting credit to a partnership than to a proprietorship because the risk of loss is spread over a number of partners rather than only one.
3. Combined Talent, Judgement and Skill:
As there are more than one owners in partnership, all the partners are involved in decision making. Usually, partners are pooled from different specialised areas to complement each other. For example, if there are three partners, one partner might be a specialist in production, another in finance and the third in marketing. This gives the firm an advantage of collective expertise for taking better decisions. Thus, the old maxim of “two heads being better than one” aptly applies to partnership.
4. Diffusion of Risk:
You have just seen that the entire losses are borne by the sole proprietor only but in case of partnership, the losses of the firm are shared by all the partners as per their agreed profit-sharing ratios. Thus, the share of loss in case of each partner will be less than that in case of proprietorship.
5. Flexibility:
Like proprietorship, the partnership business is also flexible. The partners can easily appreciate and quickly react to the changing conditions. No giant business organisation can stifle so quick and creative responses to new opportunities.
6. Tax Advantage:
Taxation rates applicable to partnership are lower than proprietorship and company forms of business ownership.
Disadvantages:
In spite of above advantages, there are certain drawbacks also associated with the partnership form of business organisation.
1. Unlimited Liability:
In partnership firm, the liability of partners is unlimited. Just as in proprietorship, the partners’ personal assets may be at risk if the business cannot pay its debts.
2. Divided Authority:
Sometimes the earlier stated maxim of two heads better than one may turn into “too many cooks spoil the broth.” Each partner can discharge his responsibilities in his concerned individual area. But, in case of areas like policy formulation for the whole enterprise, there are chances for conflicts between the partners. Disagreements between the partners over enterprise matters have destroyed many a partnership.
3. Lack of Continuity:
Death or withdrawal of one partner causes the partnership to come to an end. So, there remains uncertainty in continuity of partnership.
4. Risk of Implied Authority:
Each partner is an agent for the partnership business. Hence, the decisions made by him bind all the partners. At times, an incompetent partner may lend the firm into difficulties by taking wrong decisions. Risk involved in decisions taken by one partner is to be borne by other partners also. Choosing a business partner is, therefore, much like choosing a marriage mate life partner.
Created & Posted By Ravi kumar
CA Article at TAXAJ
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