Edited by Toluwalase Solanke
Lesson Objectives
By the end of the lesson, students should be able to:
- Define a partnership.
- List and explain features of a partnership.
- Identify sources of capital for partnerships.
- Distinguish between types of partnerships.
- Describe the different types of partners.
Table of Contents
What is a Partnership?
A partnership is a form of business organisation in which two to twenty individuals (or up to fifty in professional practices such as law and accounting) agree to come together to own and run a business with the aim of generating a profit.
Each partner may contribute money, property, or skills to the business, and the profits or losses are shared according to the terms of their agreement. The partnership is based on mutual trust and cooperation, and although the business may not have a separate legal identity from its owners, all partners are generally responsible for its operations and financial obligations.
According to the Partnership Act of 1890: A partnership is the relation which subsists between persons carrying on a business in common with a view of profit.
Features Of Partnership
1. Ownership
A partnership is formed when two to twenty individuals agree to run a business together. This range is set by law, with some exceptions—such as professional firms (e.g., law or accounting firms) that may allow more than twenty members. The owners are called partners, and they contribute resources and share the responsibilities of the business.
2. Agreement
A partnership is based on an agreement made by the partners. This agreement can be oral, written, or implied, but it is best when it is written down in a deed of partnership. The agreement outlines important terms like how profits and losses will be shared, the roles of each partner, and what happens if one partner leaves or dies.
3. Profit Sharing
In a partnership, profits and losses are usually shared among partners based on the terms of their agreement. If no specific terms are set, profits and losses are shared equally. This feature encourages cooperation and fairness among the partners, as everyone benefits from the success of the business and shares in its risks.
4. Unlimited Liability
Most partnerships have unlimited liability, which means that if the business cannot pay its debts, the partners may have to use their personal money or property to settle the debts. This makes it riskier than a company with limited liability. However, in a limited partnership, some partners (limited partners) are only responsible for debts up to the amount they invested.
5. Mutual Agency
Each partner in a partnership acts as an agent of the business, meaning any partner can make decisions and enter into contracts on behalf of the firm. These actions are binding on all partners, even if only one partner made the decision. This feature makes it important for partners to trust each other and communicate regularly.
6. No Separate Legal Entity
A partnership is not separate from its owners in the eyes of the law. This means the business does not have its own legal identity like a company does. If the business is sued or owes money, the partners are treated as the business itself. This also means that the partnership cannot own property or sue in its own name; everything is done in the names of the partners.
Sources Of Capital for Partnership
1. Personal Contributions
This is the most common and primary source of capital for a partnership. Each partner agrees to contribute a certain amount of money or assets to start and run the business. This capital may differ depending on the financial ability of each partner and the terms of the partnership agreement. The amount contributed by each partner often determines their share of ownership and how profits or losses are distributed. Since the business is jointly owned, the combined contributions of all partners help raise more funds than a sole proprietorship.
2. Loans
Partnerships can borrow money from banks or other financial institutions to raise capital for operations or expansion. Loans are usually given based on the business’s creditworthiness and the partners’ ability to repay. Sometimes, collateral may be required. The advantage of using loans is that the business can access a large sum of money without giving up ownership or control. However, loans must be repaid with interest, which becomes a financial responsibility for the partnership.
3. Retained Profits
This refers to the portion of the business’s profit that is not shared among the partners but is kept (retained) in the business. Instead of taking all the profits as income, the partners may decide to save part of it to reinvest in the business. This is a cheap and safe way of raising capital because there is no need to borrow or involve outsiders. Retained profits can be used to buy new equipment, open new branches, or increase working capital.
4. Overdrafts
An overdraft is a short-term borrowing facility provided by a bank. It allows the partnership to withdraw more money than it has in its current account, up to a certain limit. Overdrafts help the business meet urgent needs like paying salaries or buying raw materials when cash is low. However, interest is charged on the overdrawn amount, so it should only be used for short periods to avoid high costs. It is a flexible and quick way to get extra capital in times of need.
5. Grants
In some cases, partnerships may receive grants or financial support from the government, donor agencies, or non-governmental organisations (NGOs). These funds are usually given to promote small businesses, for job creation, or development in specific sectors like agriculture or education. Unlike loans, grants do not need to be repaid, making them a very attractive source of capital. However, they are not always available and may require the business to meet strict conditions or go through a competitive application process.
Types Of Partnership
There are two major types of partnerships:
1. Ordinary Partnership (General Partnership)
An ordinary partnership, also known as a general partnership, is the most common type. In this arrangement, all partners are equally responsible for the day-to-day management of the business and share profits and losses according to the agreed ratio. Each partner has unlimited liability, which means if the business incurs debts, the personal assets of the partners can be used to settle them. Decisions are typically made jointly, and all partners are involved in running the business actively. This type of partnership is common among small professional firms like law offices, clinics, and accounting practices.
2. Limited Partnership
A limited partnership includes at least one general partner with unlimited liability and one or more limited partners whose liability is restricted to the amount they invested in the business. The limited partners do not take part in the daily management of the business and have no authority to bind the firm in contracts. They mostly contribute capital and receive a share of the profits. This type of partnership is useful for investors who want to put money into a business but do not want to be involved in its operation or risk losing more than they invested.
Types Of Partners
1. Active Partner
An active partner, also known as a managing partner, is one who plays a direct role in the daily running of the business. This partner contributes capital and is involved in making business decisions, managing staff, handling customers, and overseeing operations. Because they are actively involved, they also share in both profits and losses and have unlimited liability, meaning they are personally responsible for the debts of the business.
2. Sleeping (Dormant) Partner
A sleeping partner is someone who invests money into the business but does not participate in its day-to-day activities. They do not manage or make decisions about how the business is run. However, they still share in the profits and losses according to the partnership agreement. Like the active partner, a sleeping partner usually has unlimited liability, meaning they can still be held responsible for the debts of the business even though they are not active.
3. Nominal Partner
A nominal partner is someone who does not contribute capital or take part in running the business, but allows their name to be used to give the business credibility. This person may be a well-known or respected figure, and their name helps attract customers or investors. Despite not being involved in management or investment, they may be held responsible for the debts of the business if people relied on their name in doing business.
4. Limited Partner
A limited partner contributes capital to the partnership but has limited liability, meaning they are only responsible for the debts of the business up to the amount they have invested. They are not allowed to take part in managing the business. If they do, they may lose their limited liability status. This type of partner is common in limited partnerships, where investors want to contribute funds without being involved in running the business.
5. General Partner
A general partner is a person who has unlimited liability and takes an active role in managing the business. This means they can be personally held responsible for all the debts and obligations of the business. Most partnerships have at least one general partner. General partners are also involved in decision-making and can enter contracts or make deals on behalf of the business.
Final Thoughts
A partnership is a business owned and run by 2 to 20 people who agree to share profits, losses, and responsibilities. Partnerships involve shared ownership, unlimited liability, joint decision-making, and profit-sharing among partners.
Capital is raised through partners’ contributions, loans, retained profits, overdrafts, and occasionally grants. The two main types are general partnership (equal responsibility) and limited partnership (some partners have limited liability).
Partners can be active, sleeping, nominal, limited, or general, depending on their role and liability in the business.
Read also: Telecommunications & Mobile Payment: A Perfect Partnership
