Partnership Overview

Partnership overview
What is a Partnership?
An unincorporated business structure that two or more parties form and own together is called a
partnership. These parties, called partners, may be individuals, corporations, other partnerships, or other
legal entities.
Partners may contribute capital, labor, skills, and experience to the business. They may have
unlimited legal liability for the actions of the partnership and its partners.
The most common type of partner is a general partner, who actively manages and exercises
control over the business operations.
Limited partners have limited legal liability. This type of partner cannot manage or exercise control
over the business.
Among the most common types of partnerships are general partnerships (GP), limited partnerships
(LP), and limited liability partnerships (LLP).
A partnership can even start without an oral or written contract. Where there is a written contract
between the partners, it is called a partnership agreement. The partners agree on the purpose of the
partnership and their rights and responsibilities.
A partnership splits its profit or loss among its partners. They are responsible for filing and paying
taxes for their portion of the partnership profit.

Key Highlights

 Partnerships are unincorporated businesses with two or more owners (partners) who contribute in
various ways (capital, labor, etc.) and may have legal liabilities.
 A written agreement should outline the partners’ roles, rights, and responsibilities. It can provide
clarity on capital interests, profit splitting, and business continuity in case a partner departs.
 Partnership profits and losses flow to the partners, who file and pay taxes on their portion.

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 Partnership Formation

Partnership Formation
The Partnership Agreement
When a verbal partnership agreement is used, there may be subsequent disagreements among the
owners at a later date regarding what was originally agreed to. Consequently, it makes sense to create a
written document that states how certain situations are to be handled. This partnership agreement should
at least cover the following topics:
 The rights and responsibilities of each partner
 Whether partners are designated as general partners or limited partners, since this impacts their
responsibility for the liabilities of the partnership
 The proportions of partnership gains and losses to be apportioned to each partner
 Procedures related to the withdrawal of funds from the partnership, as well as any limitations on
these withdrawals
 How key decisions are to be resolved
 Provisions regarding how to add and terminate partners
 What happens to partnership interests if a partner dies
 What steps to follow to dissolve the partnership
 The proportions of residual cash paid out to the partners in a liquidation

Contributions to the partnership

A partner may contribute the following to the partnership:

 Money – this may be in the form of bills and coins. They are recorded at face value. In case that
the money is in a foreign currency, it is recorded using the current exchange rate at the date of
contribution.
 Property – a partner may also contribute properties like land, building, office equipment, furniture
and fixtures, etc. These contributions are valued at their fair market values, on the date of
contribution. If a liability is attached to a property (like mortgage or loan), the recognized amount for
capital contribution is net of the liability.
o **Fair market value – the value at which the property can be sold at arm’s length between
two people.
 Sometimes, the partners may also agree to the amount of valuation of a property contributed to the
partnership. In cases like this, the recorded amount is the agreed value.
 Industry – when a partner’s contribution is his skills and talent, it is recorded using a memo entry.
No actual value or amount is associated with it. This happens when the partner is well-known for
his management skills, or entrepreneurial skills, or it can also be that he is well-connected and has
a network of suppliers and clients that would benefit the partnership.

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 Partnership Operations

Partnership Operations

Partner’s
Equity in
Assets
Contrasted
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 Partnership Operations

With
Share in
Profits or
Losses
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 Partnership Operations

• The basis on
which profits or
losses are
shared is a
matter of
agreement
among the
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 Partnership Operations

partners and
may not
necessarily be
the same as
their capital
contribution
ratio.
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 Partnership Operations

• The equity of
the partner in
the net asset of
the
partnership
should be

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 Partnership Operations

distinguished
from a partner’s
share in profits
or losses.
• Partners may
agree on any

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 Partnership Operations

type of profit
and loss ratio
regardless of
the amount of
their respective
capital

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 Partnership Operations

account
balances.
Partner’s Equity in Assets Contrasted with Share in Profits or Losses

 The equity of the partner in the net asset of the partnership should be distinguished from a
partner’s share in profits or losses.
 Partners may agree on any type of profit and loss ratio regardless of the amount of their respective
capital account balances.
Rules for the Distribution of Profits or Losses
1. Profits
a. The profits will be divided according to partner’s agreement.
b. If there is no agreement:
o As to capitalist partners, the profit shall be divided according to their capital
contributions.
o As to industrial partners (if any), such share may be just and equitable under the
circumstances, provided, that the industrial partner shall receive such share before
the capitalist partners shall divide the profits.
2. Losses
a. The losses will be divided according to partner’s agreement.
b. If there is no agreement as to the distribution of losses but there is an agreement as to profits,
the losses shall be divided according to the profit sharing ratio.
c. In the absence of any agreement:
o As to capitalist partners, the losses shall be divided according to their capital
contributions.
o As to purely industrial partners (if any), shall not be liable for any losses.

Distribution of Profits or Losses based on Partners’ Agreement

1. Equally or in agreed ratio
2. Based on the partners’ capital contributions
a. Ratio of original capital investments
b. Ratio of capital balances at the beginning of the year

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 Partnership Operations

c. Ratio of capital balances at the end of the year

d. Ratio of average capital balances
3. By allowing interest on partners’ capital and the balance in an agreed ratio.
4. By allowing salaries to partners and the balance in an agreed ratio.
5. By allowing bonus to the managing partner based on profit and the balance in an agreed ratio.
6. By allowing salaries, interest on partners’ capital, bonus to the managing partner and the balance
in an agreed ratio (combination of 3 to 5).

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 Partnership Dissolution

Partnership Dissolution
The dissolution of a partnership may be defined as altering the business relationship between
partners. Dissolution is the first step in the termination of a partnership and occurs when at least one of the
partners in the business partnership is no longer part of the business. When a partnership is dissolved, the
individuals in the business partnership are no longer legally bound, but the partnership proceeds until a
time when the business' debts are settled, the legal existence of the business is ended, and the lingering
assets of the business have been properly shared.
An example of the dissolution of a partnership can be when certain gambling activities are made
illegal in some countries. Business partnerships that conduct such gambling activities are considered
dissolved as their brand of gambling is no longer legal. Additionally, if one of the partners were to be
declared mentally unstable, the partnership would be dissolved.

Causes of general dissolution

The general dissolution of a partnership will usually be instigated as a result one of the following events: 
 The mutual agreement of the partners – which may be an ad hoc agreement, or an agreement
enshrined in the partnership agreement (where, for example, it was agreed that the partnership
would be dissolved after a particular date, or after a certain event).  Such an agreement may be
implied rather than actual. 
 By the serving of a notice by a partner where such an action provided for in partnership
agreement. 
 The exercise of a specific power in the partnership agreement – where, for example, the
partnership agreement allowed a majority of the partners to seek dissolution. 
 The exercise of a power in the legislation. 
 One of the events provided for in the legislation (e.g., the death or bankruptcy of a partner) –
subject to contrary agreement. 
 Fraud, misrepresentation, rescission or illegal activity. 
 By an order of court (following, for example, the mental incapacity or other ill-health of a partner). 
 Where the business may only be carried on at a loss.

The dissolution of partnership takes place in any of the following ways:

1. Change in the existing profit sharing ratio.
2. Admission of a new partner
3. The retirement of an existing partner
4. Death of an existing partner
5. Insolvency of a partner as he becomes incompetent to contract. Thus, he can no longer be a
partner in the firm.
6. On completion of a specific venture in case, the partnership was formed specifically for that
particular venture.
7. On expiry of the period for which the partnership was formed.

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 Partnership Liquidation

Partnership Liquidation
Partnership liquidation is the process of closing the partnership and distributing its assets. Many
times partners choose to dissolve and liquidate their partnerships to start new ventures. Other times,
partnerships go bankrupt and are forced to liquidate in order to pay off their creditors. Either way, the
partnership liquidation process is similar.
What Does Partnership Liquidation Mean?
The partnership liquidation process starts with the partnership selling off all of its noncash assets at
auction. Most of the time these assets will create a loss because they will be sold for less than what the
partnership purchased them for, but some assets, like building, can appreciate and be sold at a gain. Both
the losses and gains from these sales are allocated to the partners’ capital accounts based on the
partnership agreement.
Order of Liquidation
The liquidation of a partnership starts with a review of the company's assets, including property and
cash, and its debts. The partners then sell the company's assets, which can result in a gain or a loss. The
money received from selling the assets goes to pay the debts the company owes, even if the company sells
the assets for less then their worth. The partners receive money from the liquidation of the business last,
after the debts have been paid off.
Division of Funds
The amount of money each partner receives after paying the company's debts depends on the
amount left in his capital account.
Debt Balance
Sometimes the sale of a company's assets doesn't provide enough money to pay off all the
company's debts. In such a case, the rest of the money comes from the capital accounts of each partner.
The percentage of the losses for which a partner is responsible depends on the partnership agreement. For
When one of several partners cannot pay the owed share of the money, the other partners pay that
partner's share, splitting the remaining balance based on agreed-upon loss-sharing percentages. The
partners who did fulfill their obligations can later sue the partner who failed to pay for the money owed if
desired.
Insolvent Partnership
If the company's debts after selling assets are more than the funds in all the partners' capital
accounts combined, and none of the partners can pay from personal funds, creditors do have recourse for
getting the money owed. In such a case, creditors can usually claim and resell personal assets that belong
to the partners. In addition, each partner is personally liable for the entire debt owed, even if any given
partner had only a small partnership interest in the business.

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