Most successful, fast-growing businesses are founded by two or more partners, as opposed to just a sole proprietor. Clearly there are benefits to having one or more partners by your side. Partners help share the workload, balance out each other’s weaknesses, and provide support and encouragement when the going gets tough.
However, partnerships also give rise to many more disputes and disagreements, some of which end up being settled in court or even result in failure of the business. For this reason, it’s a good idea to educate yourself about business partnership basics. The more you understand how each type of business partnership operates and what rights and responsibilities the partners have, the more likely you will be to avoid conflicts with your business partners down the road.
The simplest form of partnership is often called a general partnership. Similar to a sole proprietorship, no official documents need to be filed in order to enter into a general partnership. Management and liability are shared equally between the partners, and any partner can sign contracts for the business. Taxes are also the same as with a sole proprietorship in that profits and losses flow through to the personal income taxes of the owners (known as pass-through taxation).
The Uniform Partnership Act defines a general partnership as “The association of two or more persons to carry on as co-owners of a business for profit… whether or not the persons intend to form a partnership.” This loose definition can mean that you may enter into a partnership whether you intend to or not.
Generally, any time two or more people are working towards a profit—sharing management and sharing financial risk—a partnership has been formed by default. This is important to note because, unlike a limited liability entity, all partners in a general partnership are personally responsible for the debts and liabilities of the business.
Limited partnerships are good for investing and as tax havens. Within a limited partnership, there are two classes of partners: General Partners and Limited Partners.
General Partners are similar to those in a regular partnership; they manage the company and are personally liable for the company’s debts. Limited Partners are basically investors; they contribute capital and share profits, but do not manage the day to day operations, and have the protections of limited liability for the debts of the company. This means they are only liable for company debts up to the amount of capital they invested within the company.
Because limited partnerships offer limited liability for Limited Partners, formation of a limited partnership typically requires a state filing (although some states, including California, allow for the oral creation of limited partnerships). Limited partnerships enjoy pass-through taxation, which makes them a good tax shelter for investors in the early years of a business. The initial losses that are typical with the formation of a new business can be applied to personal income taxes, reducing taxable income for all partners.
Recently, the limited partnership business structure has become less popular and is being replaced by Limited Liability Companies (LLCs), which provide all the benefits of a partnership but with more protection for the managing partners.
Limited Liability Partnerships (LLP)
LLPs may only be formed between licensed professionals such as dentists, attorneys, or accountants. LLPs are similar to general partnerships, but LLP partners are only liable for their own actions, not the actions of their partners. LLPs need a partnership agreement to establish limited liability among partners.
Although partnership agreements aren’t generally required by law for all forms of partnerships, it is highly recommended to draft one up for any partnership you may be entering into. Partnership agreements help clarify how ownership is shared, how decisions are made, and how the partnership will be affected by events such as the death or withdrawal of a partner.
Partnerships can be an easy and inexpensive way to run your business with less legal paperwork and formalities involved. But they can also be risky in regards to your personal liability. For that reason, it may be wise to consider another type of business structure like an LLC or Corporation – here is a basic overview of different business structures to get you started.
Regardless of what business you are starting, it is a good idea to discuss your business aspirations with an experienced business attorney in order to choose the business structure that best suits your needs.
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