Partnerships are akin to joint ventures where two or more parties agree to act in concert to earn a profit. Partnerships are recognized as separate entities from their owners under state law.
Partnerships involve shared liability and management, which means that each partner is personally responsible for the debts and obligations of the partnership and each partner has an equal say in the decision-making of the business.
Most partnerships are formed given they are simpler to form and operate than other business structures, such as corporations.
Potential Benefits of Forming a Partnership
There are several potential benefits to forming a partnership:
- Shared liability: Partnerships offer shared liability, which means that each partner is personally responsible for the debts and obligations of the partnership. This can be beneficial for businesses that want to share the risks and rewards of ownership.
- Shared management: Partnerships allow for shared management, which can make it easier to divide responsibilities and workload among the partners.
- Cost and simplicity: Forming and operating a partnership is generally less expensive and simpler than other business structures, such as a corporation.
- Pass-through taxation: Partnerships are generally taxed as “pass-through” entities, which means that the partnership itself is not taxed on its profits. Instead, the profits and losses of the partnership are passed through to the individual partners, who report them on their personal tax returns. This can be simpler and more tax-efficient than other business structures.
- Ability to raise capital: Partnerships can raise capital by bringing on new partners or by obtaining loans or investments.
Potential Drawbacks of Forming a Partnership
There are several potential drawbacks to consider when forming a partnership:
- Shared liability: While partnerships offer shared liability, this means that each partner is personally responsible for the debts and obligations of the partnership. This can be a disadvantage for partners who want to limit their personal liability. The limited partnership or limited liability partnership can provide a remedy for this.
- Loss of control: In a partnership, each partner has an equal say in the management and decision-making of the business. This can be frustrating for partners who are used to having complete control over their own businesses.
- Difficulty in ending the partnership: It can be difficult to end a partnership, especially if the partners do not agree on how to dissolve the partnership or distribute the assets of the business. This can create ongoing conflicts and may require the assistance of a lawyer or mediator to resolve.
- Complexity: While partnerships are generally simpler to form and operate compared to corporations, there are still specific rules and requirements that must be followed. It’s important to understand and comply with these requirements to ensure that your partnership is operating properly.
- Lack of prestige: Partnerships may not have the same level of prestige as corporations, which can be a disadvantage for businesses that want to project a professional image or attract customers and partners.
Types of Partnerships
In most states, a partnership can either be a general partnership, limited partnership, or limited liability partnership.
Start-ups with multiple owners testing a business idea before a full business launch usually form a general partnership. They are also used in joint venture situations. Most joint ventures are general partnerships that will exist until the project is completed or up to a determined date.
Each partner in a general partnership will have the same authority and responsibility under a general partnership.
A general partnership is formed by an agreement by two or more persons or entities to engage in a business. This usually requires an agreement to share profits and losses. No filing is necessary to create a partnership, but it is advisable to have a partnership agreement in place (and it should be noted that the partnership still needs to comply with other business registration, filing, and tax requirements).
The partnership agreement is the governing document in a partnership. The partnership agreement defines the responsibilities of each partner and outlines ownership interests and rights. It is similar to “By Laws” for a corporation or the “Company Agreement” in an LLC. Partner disputes are common. They often end up in court. Written partnership agreements can go a long way in avoiding these types of costly disputes.
Partners in a general partnership have no personal liability protection. All partners can be jointly and severally liable. When a partner facing a lawsuit has no money, an individual may go after the partnership and sue to receive compensation by forcing other partners to be liable. This is why most partnerships are limited partnerships or limited liability partnerships.
Business owners wanting to limit a partner’s exposure or authority can create a Limited Partnership or LP. Investors and business owners often form limited partnerships to raise capital for certain assets or investments.
A limited partnership requires at least one general partner with unlimited liability and one or more limited partners. Limited partners are not liable beyond their initial investment, as long as they have not taken an active role in the partnership.
LPs are not required to file the partnership agreement with the state, but they usually have to file a certificate of formation with the state.
Limited Liability Partnership
Many states also provide for Limited Liability Partnerships or LLPs, which is another type of partnership structure. This business structure is a hybrid between a corporation and a general partnership.
With an LLP, all partners are limited partners and they are not responsible for the actions of other partners. This business structure is ideal for practicing professionals, like accountants and lawyers.
LLPs have to file a certificate of limited partnership with the state.
It’s important to carefully consider the potential benefits and drawbacks of forming a partnership before making a decision. Call us to get more information and advice on the suitability of a partnership structure for your situation.