As businesses grow especially when there is more than one owner, they need to evolve into organisational forms beyond sole proprietorship. The form of business organisation can be decided keeping in mind several aspects such as nature and scale of the business as well as number of owners and relationship between them.
This article looks at meaning of and differences between two forms of organisation –partnership firm and company.
Definitions and meanings
A partnership firm may or may not have a separate and identifiable legal entity from that of its partners depending on the nature of partnership – limited or unlimited partnership.
In a limited partnership, the liability of the partners is limited i.e.: their liability for dues of the business is restricted to a pre-determined quantum (generally their respective capital contributions). Thus they are not personally liable for the business’ dues which make the legal identity of the partners and partnership firm distinct.
In an unlimited partnership, the liability of the partners is unlimited i.e.: their liability for dues of the business extends as their personal liability and thus their personal assets as well can be held liable for recovery. In this case there is no real distinct legal entity of the partnership firm in relation to the partners.
Partnership firms are guided by an agreement between its partners termed as a partnership agreement. This agreement lays down terms related to aspects such as capital contributions, profit sharing terms, salary and interest, if any payable to the partners and profit sharing ratio etc.
A company is a form of business organisation that involves incorporation of a separate legal entity to house the operations of a business with the intention of earning profits for its members. In a company, the total capital is divided into multiple parts of pre-determined denomination termed as shares. Entities become members/part-owners of the company by purchasing one or more shares of the company. The members of a company are thus termed as shareholders.
A company must have a minimum of two shareholders and there is generally no limitation on the maximum number of shareholders that a company (especially public company) can have.
The key feature of a company is that it has a separate and distinct legal entity from its members. The liability of shareholders is thus limited to the extent of the face value of their shares in the company. A company also has the feature of perpetual succession i.e.: its existence is not affected by the death/dissolution of one or more of its members.
A company must be incorporated and registered under the law governing companies in the specific jurisdiction.
The profit of the company can be distributed to its shareholders in the form of dividend.
Difference between partnership firm and company
The differences between partnership firm and company have been detailed below:
A partnership firm is a form of business organisation in which two or more entities come together to run a joint business with the intention of earning profits.
A company is an incorporated entity that comprises of multiple members who have collectively contributed to its capital, formed with the intention of running a business.
The members/owners of a partnership firm are termed as partners.
The members/owners of a company are termed as shareholders
Minimum and maximum number of owners/members
A partnership firm requires a minimum of 2 partners, the maximum number of partners is determined by the jurisdictional law.
A company requires a minimum of 2 shareholders. The maximum number of shareholders permitted is different for a private company (limited by jurisdictional law) and a public company (unlimited).
Mode of creation
A partnership firm comes into existence by entering into partnership agreement between the partners.
A company comes into existence by incorporation under the jurisdictional companies act. The memorandum of association and articles of association become its charter documents.
Necessity of registration/incorporation
It is not mandatory for a partnership firm to be registered.
As a company is an incorporated entity, registration under the law is mandatory.
Partnership firms are governed by partnership laws of the specific jurisdiction. For example in the USA, every state has its own state level partnership law, the Indian Partnership Act in India etc.
Companies are governed by corporate laws of the specific jurisdiction. For example – Companies Act 2013 in India.
In the case of a partnership firm, whether it has a separate legal entity than that of its partners depends on the type of partnership. An unlimited partnership does not have a distinct and separate legal entity whereas a limited liability partnership has a distinct and separate legal entity.
A company is an incorporated entity and thus has a distinct and separate legal entity from its shareholders.
In an unlimited partnership, the partners are personally liable for debts and obligations of the business. In limited liability partnership, the liability of partners is limited generally to their respective capital contribution.
In a company, the liability of the shareholders is limited to their capital contribution. Shareholders are not personally liable for debts and obligations of the business.
Partnership firms generally have less statutory compliance that need to be followed.
Multiple and more stringent statutory compliances such as reporting requirements, accounting and auditing standards, etc are applicable to companies.
Management and decision making
In a partnership firm, management and decision making is the prerogative of the partners itself.
In a company, the management and to some extent decision making is delegated to a board of directors. Decisions are taken by board resolutions and in several cases by shareholder resolutions.
In case of a partnership firm, its continuity depends on the type of partnership and terms of the partnership deed. An unlimited partnership generally does not have perpetual succession.
A company has perpetual succession in that its continuity is not impacted by change of its members.
Partnership firms are preferred by medium sized especially family run business where the number of partners required are limited and where limited number of statutory compliances are preferred.
Company form of business organisation is preferred by larger businesses that require a separate legal entity and that require extensive funding from multiple owners. Additionally several countries offer several tax and other benefits only to companies – businesses may prefer company form so as to take benefit of these sops.
Conclusion – Partnership firm vs company:
Both partnership firm and company form of business organisation have certain benefits and drawbacks. As businesses grow, company form is preferred as it provides more opportunities for growth – through infusion of more equity from greater number of members, public participation in equity, participation in several scheme and sops reserved for companies etc.