What are the 5 essential elements of a Partnership firm

What are the 5 essential elements of a Partnership firm

Legal & Compliance

Vakilsearch Staff

Vakilsearch Staff

2 Jun 2022, 11:39 — 7 min read

A partnership firm is a firm owned by two or more persons in an agreement, and the business’s profit will be shared between them. The business can be run by one of them on behalf of all or jointly by all. The Indian Partnership Act 1932 governs the partnership firms in India.

 

Elements of Partnership Firm

As there may be several persons involved in partnership firms, there must be a set of rules for the proper functioning of firms. Five essential elements combine to make a partnership firm, failing which it cannot be identified as a partnership firm.

 

1. Contract

A proper contract between the persons in business is necessary. This contract can’t be related, inherited or imposed by law. If certain members in a family are jointly running the business, it can’t be said that they are partners of the firm. Partners are only those persons from whom a contract is signed.

In the case of the Joint Hindu Family (HUF), the members can’t be partners. If any family member wants to be a partner in a firm, he/she has to sign a contract with other members.

2. Partners

For a firm to be in partnership, there must be at least two persons in the contract. There are set limits too. If there is a Banking sector firm, there can be ten partners, whereas, in any other sector firm, it is 20. If the number of partners exceeds these limits, the partnership firm will be declared illegal.

A partnership can be between two companies, but it will be counted as an individual. The partnership firm can’t be taken as a single independent entity in case of a partnership between firms. Every individual is in partnership with the other members of the firm.

 

3. Business

Business here specifically means a business that is focused on making a profit. If the business is not making a profit or is a non-profit organisation, then it can’t be said to be a partnership firm.

Also, if two people start a new business set up by dividing the investments between them, they can’t be said partners unless there is a contract between them and it is a profit-making business. They can be called co-owner but not partners.

 

4. Profit Share

The profit earned by a partnership firm should be divided between each firm member. The share ratio between the partners can be decided by the members themselves, but it can’t happen that only one or two members get all the profits.

 

There are no set rules for losses incurred in a partnership; it can be shared by each member or by some members only. It depends on the partners. The partner(s) having most liability incurs the losses mostly. It can also happen that losses are in the same ratio as profit.

 

5. Mutual Agency

Any decision taken by any of the partners in the partnership needs to be followed by all. Everyone is equally responsible for any decision taken by any partner. A partner acts as an agent as well as the head of the company. He/she can represent the firm on behalf of others and vice versa.

 

Mandatory Element of a Partnership Firm 

Apart from these essential elements, the mandatory element of a partnership firm is the Partnership Deed. It mainly consists of the nature of business, details of partners, capital contribution, and duration of partnership; it can be a project-based or contractual partnership. The profit share ratio also needs to be described in the partnership deed.

 

A partnership deed is very significant before starting a partnership firm. It keeps in check the rights, duties and liabilities of each partner. It helps in conflict resolution and settling disputes between the partners as everything is clearly stated beforehand in the partnership deed. The agreement of all partners signs the deed, and no one can breach that. The profit sharing and salary or interest to be paid out are mentioned on the partnership deed.

 

Merits of Having a Partnership Firm

Partnership in a business helps ensure proper workflow while effectively distributing the share of responsibilities. It also helps in better decision making. With the involvement of partners, weak aspects and strong aspects of partners combine to provide stability.

 

Besides, each partner has unique qualities and capabilities, which can greatly benefit the organisation. For example, one partner may have a good network of clients, while another one could be smarter at retaining the clients. Moreover, capital investment increases with the partnership as a partnership has better credibility and stability in the market.

 

The customer base increases due to the partnership, and it widens both company’s perspectives and knowledge. It helps in gaining a competitive advantage over a tough competitor. It also provides long term stability and assurance to the firms and customers.

 

Disadvantages of Setting up a Partnership Firm

It may happen that the partnership is not working as expected, resulting in a line of disputes and conflicts between the partners. Further, a partnership firm has unlimited liability and uncertain existence, leading to a loss of faith in its reliability among existing and potential clients. Besides, since every partner exercises authority, they may look for personal gains instead of the firm. Sometimes, the decision-making process can seem way daunting as each partner may have different views.

 

A partnership firm is more advantageous as businesses prosper with more availability of resources. It can be a stepping stone for newcomers or support for failing companies.

 

Bottom Line

Navigating the legal landscape for ensuring the efficient operation of your business may turn out more complex than you can imagine. However, with professional legal experts by your side, the process can become simpler to a great extent. 

 

Also read: How does a Franchise Agreement work?

 

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Image source: Canva

 

Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views, official policy or position of GlobalLinker.

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