Advantages & Disadvantages of a Partnership | Capital One

Despite their benefits, business partnerships may have certain disadvantages. While some drawbacks are impossible to avoid, understanding them may help you decide if a partnership is right for your business. It may also help you prevent, identify and mitigate the cons of any potential partnership.

1. Loss of autonomy

As noted above, important business decisions should be made in collaboration with your business partner. While this has benefits, it also limits the control you have over your business, and it may lead to longer, more complex decision-making processes. When entering a business partnership, you should be prepared to compromise on some aspects of the business and operations, as compromise is necessary for you and your partner to be a successful team.

2. Unlimited liability

In a business partnership, there is rarely any established business liability, which means that business liabilities are typically you and your business partner’s personal responsibility. The decisions you and your partner make together about your business finances could also impact each of you personally.

Often, business partners are held jointly and severally liable, which means that you may be individually responsible for any business debts your partner is unable to pay. If, for instance, your business permanently closes due to financial stress with $50,000 of remaining debt and your partner’s personal assets only total $20,000, you may be personally responsible for the remaining $30,000. Creditors may even seize your personal property to recover the debt they are owed.

3. Taxation

Business partnerships generally do not pay income tax at the business level. All earnings and losses are “passed through” to the individual partners. Each partner reports their share of the business’s earnings and losses on their annual tax return, paying individual taxes on the business’s earnings accordingly. 

Partnership earnings are subject to self-employment tax rates, and partners may end up paying more in taxes than a differently structured business would. Profits must also be claimed and taxed in the year they are earned. Unlike a limited liability company (LLC), profits cannot be retained in the partnership to be drawn as income later at a lower tax rate.

So how does this differ from being the sole owner? Let’s say you open a high-end flower delivery business. In the past year, it earned a profit of $150,000 after you paid your own salary. If the business is structured as an LLC or a sole proprietorship and you are the sole owner, you would report the whole $150,000 on your personal tax return and be taxed accordingly. In a 50/50 partnership, you and your partner would each claim 50% of the business’s profit (or $75,000) on your individual tax returns, reducing your individual tax liability.

When considering a business partnership, consult a tax professional for input on the benefits and drawbacks of different business structures. You can learn more about tax implications for business partnerships from the IRS.

4. Potential for conflict

Because money and livelihoods may be at stake, it’s not uncommon for disputes to arise among business partners due to factors such as conflicting business values or perceived unequal efforts. When considering a prospective partner, try to ensure they share your work ethic, vision and values before entering a business partnership. It may also be beneficial if they are calm, rational and skilled at communication.

5. Exit strategy complications

If you or your partner decide to sell their share of the business, problems may arise if all partners aren’t in agreement. Disputes could derail the sale of the business shares or cause soured emotions between all parties. Exit strategies may be worked into a written business contract with your partner to help enable a smooth transition if one partner wishes to leave the company. One example is a “right of first refusal” clause that allows you to buy your partner’s share of the business before they sell to someone else, avoiding third-party involvement in your company. It’s wise to consult a business attorney for guidance in crafting exit strategies and selling business shares.