Management > General Management > Forms of Business Organizations > Partnership
The sole proprietorship form of the organization suffers from certain limitations such as limited resources, limited skill, and unlimited liability. To expand business more capital, more time and managerial skills are required. There may involve more risk. This disadvantage of sole proprietorship call for more persons come together, with different knowledge, skills, and financial resources and start a partnership firm.
L H Haney defines partnership as it is the relation between persons competent to make contracts who have agreed to carry on a lawful business in common with a view to private gain.
According to J. L. Hanson, “a partnership is a form of business organization in which two or more persons up to a maximum of twenty join together to undertake some form of business activity”.
According to The Indian Contract Act, 1872 “Partnership is the relation which subsists between persons who have agreed to combine their property, labour or skill in some business and to share the profits therefrom between them.
The Indian Partnership Act, 1932 defines partnership as “the relation between persons who have agreed to share the profit of the business carried on by all or any one of them acting for all.”
The entity formed by such partnership is collectively called a “Partnership Firm” and all the individual members are called the “Partners” of the firm. The name under which partnership business is carried on is called ‘Firm Name’. A partnership business solely rests on utmost good faith and trust among the partners.
Feature of Partnership:
- Formation: The partnership form of business organization is governed by the Indian Partnership Act, 1932. It comes into existence through a legal agreement wherein the terms and conditions governing the relationship among the partners, sharing of profits and losses and the manner of conducting the business are specified. Thus a contract between the partners must be created to form a partnership firm. A partnership firm is not a separate legal entity. The business carried out by partnership firm must be lawful and should have the motive of profit. If two or more people come together for charitable or social purposes, then it does not constitute a partnership.
- Liability:
- The partners of a firm have unlimited liability. The partners are all individually and jointly liable for the firm and the payment of all debts. Personal assets may be used for repaying debts in case the business assets are insufficient. All the partners are responsible for the debts jointly and they contribute in proportion to their share in the business and as such are liable to that extent. Individually too, each partner can be held responsible for repaying the debts of the business. If the money is recovered from a single partner, then such a partner can later recover from other partners an amount of money equivalent to the shares in liability defined as per the partnership agreement and has the capacity to sue other partners.
- Risk Bearing: The partners bear the risks involved in running a business as a team. The reward comes in the form of profits which are shared by the partners in an agreed ratio. However, they also share losses in the same ratio in the event of the firm incurring losses.
- Continuity:
- A partnership cannot carry out in perpetuity. The death, retirement, bankruptcy, insolvency or insanity of any partner can bring an end to the business. In such a case, the remaining partners may if they so desire to continue the business on the basis of a new agreement. Similarly, the partnership of a father cannot be inherited by his son. If all the other partners agree, he can be added on as a new partner.
- Restrictions on Transfer of Share: No partner can transfer his share to any outside person without seeking the consent of all other partners. Even the partnership of a father cannot be inherited by his son. If all the other partners agree, he can be added on as a new partner.
- Decision making and control: The partners share amongst themselves the responsibility of decision making and control of day to day activities. Decisions are generally taken with mutual consent. Thus, the activities of a partnership firm are managed through the joint efforts of all the partners.
- Principal-Agent Relationship: The partnership firm may be carried on by all partners or any of them acting for all. While dealing with the firm’s transactions, each partner is entitled to represent the firm and other partners. In this way, a partner is an agent as well as the principal of the firm and agent of the other partners.
- Membership: The Partnership Act itself is silent on this issue, but the Companies Act, 2013 provides clarity about the membership in a partnership firm. The minimum number of members needed to start a partnership firm is two, while the maximum number, in case of the banking industry, is ten and in case of other businesses, it is twenty. If the number of partners increases beyond the prescribed limit, then it will become an illegal entity or association.
Merits of Partnership:
- Ease of Formation and Closure: Partnership is a contractual agreement between the partners to run a firm. Hence, it relatively eases to form due to minimal legal requirements. The registration of a partnership is desirable, but not obligatory. Hence a partnership firm can be formed easily by putting an agreement between the prospective partners into place whereby they agree to carry out the business of the firm and share risks. Closure of the firm is also an easy task.
- Balanced Decision Making and Judgment: As it is said that combined abilities and judgment, when properly integrated produce a result that becomes appreciably greater than the sum of all individual capacities. As there are more than one owners in partnership, all the partners may be involved in decision making. The partners can oversee different functions according to their areas of expertise. Because an individual is not forced to handle different activities, this not only reduces the burden of work but also leads to fewer errors in judgments. This gives the firm advantage of collective expertise for taking better decisions. As a consequence, decisions are likely to be more balanced.
- More Funds: The greatest advantage of partnership over sole proprietorship is that the partnership enjoys large resources than a sole proprietorship. In a partnership, the capital is contributed by a number of partners. The partnership firms can also arrange money from the outside sources. This makes it possible to raise a larger amount of funds as compared to a sole proprietor and undertake additional operations when needed. Thus the advantage of economies of scale can be taken.
- Sharing of Risks: The risks involved in running a partnership firm are shared by all the partners. This reduces the anxiety, burden, and stress on individual partners.
- Secrecy: Such a firm is not legally required to publish its accounts and submit its reports. Hence it is able to maintain the confidentiality of information relating to its operations.
Demerits of Partnership:
- Unlimited liability: The liability of the partners for the debts of the business is unlimited. Partners are liable to repay debts even from their personal resources in case the business assets are not sufficient to meet its debts. The liability of partners is both joint and several which may prove to be a drawback for those partners who have greater personal wealth. They will have to repay the entire debt in case the other partners are unable to do so.
- Limited resources: There is a restriction on the number of partners in a firm. There can be a minimum two and maximum of 20 partners in a partnership firm. In order to secure harmony amongst the members of the firm, generally, the number of partners is kept smaller than allowed by the law. Hence contribution in terms of capital investment is usually not sufficient to support large scale business operations. As a result, partnership firms face problems in expansion beyond a certain size.
- Possibility of Disharmony and Conflicts: Partnership is run by a group of persons wherein decision-making authority is shared. The difference in opinion on some issues may lead to disputes between partners and may lead to disharmony and lack of management in the business. Decisions of one partner are binding on other partners. Thus an unwise decision by anyone partner may result in financial ruin for all others. When differences arise, each partner tries to blame the other partner about his dishonest dealings and working against the interest of the firm. This may result in disruption and ultimate dissolution of the firm.
- Transferability: Absent an agreement to the contrary, the default rule in partnerships is that one person’s stake cannot be transferred to another without prior consent from all of the remaining partners. This inflexibility is especially undesirable when the parties have existing disagreements. In case a partner desires to leave the firm, this can result in termination of partnership as there is a restriction on the transfer of ownership. This restricts the liquidity of his investment.
- Lack of Continuity: Partnership comes to an end with the death, retirement, insolvency or lunacy of any partner. The partnership may come to end if a single partner expresses his desire to dissolve the partnership or to get it dissolved by the order of the court on account of the wrongful act of one or more other partners. The lack of trust among the partners may lead to the dissolution of the firm. It may result in a lack of continuity. However, the remaining partners can enter into a fresh agreement and continue to run the business.
- Unclear Authority: In partnership, there may be a potential vagueness of each person’s responsibilities, both to those in the partnership and to those outside it. A traditional partnership is an equal stake with equal authority distributed between the members. There is no hierarchy of authority. To third parties, this means that all partners act on behalf of the partnership, can enter into contracts, and by the same token, bind the partnership into unwanted agreements.
- Lack of Public Confidence: A partnership firm is not subject to any regulation and no legal formation and functioning. It is not legally required to publish its financial reports or make other related information public. Hence it is difficult for any member of the public to ascertain the true financial status of a partnership firm. Similarly, the public listen to too many stories regarding frauds by partners and dissolution of partnership firms. Hence the confidence of the public in partnership firms is generally low.
- Burden of Implied Authority: Each partner is an agent for the firm and for remaining partners. When anyone partner who is lazy, negligent or creates some blunder, guilty of corrupt practices or playing foul, then other partners are equally liable financially and without limit for his act. It puts a heavy financial burden on remaining partners which lead to the closure of the firm.
- Liability After Retirement: In this form of business organization, the retiring partner continues to be liable for all acts done when he was a partner. Retiring partner must give a public notice of his retirement otherwise he would be held responsible for the acts of other partners even after retirement.
Conclusion:
From the above discussion, we can conclude that the partnership form of organization is suitable where the size of the business is relatively small and the capital requirements are not high. In spite of inherent limitations, the partnership still might prove to be a superior option for many due to its flexibility and informality. This form of business organization is most popular among retail traders, lawyers, chartered accountants, doctors, solicitors, and estate agents.
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