A partnership is a specific type of business with more than one owner. Generally, a business with multiple owners that has not filed any paperwork with the state to become a corporation or an LLC is labelled a partnership.
There are two basic types of partnerships: general partnerships and limited partnerships.
General partnerships have two or more partners who come together to operate a business. The partnership can be formed with or without a formal agreement. All of the partners share in the business, meaning that they share the profits, debts, and liabilities of the business. All of the partners can also be held personally liable for debts and liabilities.
A limited partnership is similar to a general partnership, but with key distinctions. In a limited partnership, there are one or more limited partners and one or more general partners. The limited partners’ role in the business is limited to investing capital, while the general partners make the management decisions and work on the day-to-day operations.
All of the risk of the business is assumed by the general partners, who take on all the debts and liabilities of the limited partnership. The limited partners only risk their financial contribution (and their liability is limited to the amount of their financial contribution to the business). In most cases, all the partners in a limited partnership share in the profits of the business.
Whenever you are starting a new business, it is important to do your research. Many states and municipalities have certain requirements for businesses (including obtaining business licenses or permits, or filing certain paperwork with the correct governmental agencies) before you can begin operation.
Control of the business boils down to a few things: ownership, management, and authority to do business.
- Ownership: In a general partnership, a formal partnership agreement sets forth the percentage of ownership each partner has in the business, as well as the percentage of profits.
- If you don’t have a partnership agreement, or if the agreement does not specify ownership interests, then each partner owns an equal share in the profits and liabilities of the business.
- Management: The partnership agreement should also lay out who controls and manages the business (this is usually an important element to get in writing, so there is a standard answer and agreement among the partners).
- If there is no partnership agreement, or if the agreement does not specify this element, then the general partners will share control and management rights of the business equally.
- Doing Business on Behalf of the Partnership: This does not pertain so much to the day-to-day transactions, but regards contracts and legal obligations of the business (like renting a storefront, or paying vendors).
- Any general partner can commit the partnership and the individual partners without their approval. Limited partners, because of the limited nature of their involvement, normally do not have this kind of power.
Liability is a big question when it comes to business entities, especially partnerships. In a general partnership, the partnership can conduct business as a separate legal entity. However, the general partners are liable both together and individually for all of the liabilities and debts of the company.
That means that each individual partner can be sued for — and required to pay — the full amount of any business debt. If the company owes money, a creditor can seek the business debts from an individual partner. However, the partner can seek reimbursement from the other partners for their share of the debt.
Because of the partnership’s unique blend of personal liability for all partnership debt and the authority of each partner to bind the partnership to agreements, it is extremely important that you trust the people that you start your business with.
Limited partners do not have personal liability to the company. Instead, a limited partner’s liability is limited only to the contributions that they have made to the partnership.
One way for partners to avoid the personal liability aspect of the partnership is to change the structure of the business — if the general partnership votes to become a limited liability partnership, or LLP, then they can do away with the personal liability aspect of the general partnership.
Generally speaking, a partnership does not pay taxes on the income generated by the business. Instead, it’s what the IRS considers a “pass-through entity.” The individual partners pay taxes on their share of the business income. The business income “passes through” the business to the partners, and the partners report their shares of profits and losses on their individual income tax returns.
In addition, partners are required to pay self-employment tax on their partnership income. If you have questions about how partnerships are taxed, and whether you need to change your organization for beneficial tax reasons, you may want to consider talking to a CPA or a tax attorney.
There is no fancy paperwork required to create a partnership — just agreeing to go into business with another person is enough to get you started.
However, there are some things that are a really good idea to get in place if you are going into business with a partner. The company must meet the same local registration requirements as other new businesses, such as filing the correct registration paperwork with the proper governmental authorities.
You may have to get an employer identification number (EIN) from the IRS for taxes, a business license, or a zoning permit from your local planning board. If the partnership is going to be doing business under an assumed business name, you usually have to register that name with your county clerk of court.
You are not legally required to have a written partnership agreement, but it would be in the best interests of the business (and all of the partners as well) to put the details of ownership, including the partners’ rights and responsibilities, into a written agreement.
The existence of the partnership is more delicate than that of a different type of business (like an LLC or corporation). If a general partner dies or leaves the company, the partnership becomes subject to dissolution.
In that case, the remaining partners must fulfill any of the company’s remaining business obligations, pay off all the debts, and divide the assets and profits among themselves (hopefully according to terms already set forth in a written partnership agreement).
To prevent this kind of ending to your company, you can have certain provisions included in your partnership agreement. A buy-sell agreement (or buyout agreement) helps the remaining partners plan for what will happen when one partner dies, retires, becomes disabled, or leaves the company. For example, this kind of an agreement might allow the partners to buy out a departing partner’s interest, allowing business to continue as usual.
If you are interested in starting a business, or change the form of your business entity, it is in your best interests to consult a corporate lawyer or business lawyer. The right lawyer can help you talk through your situation and make the best decisions for your business going forward.
If you are interested in having a formal partnership agreement drafted, your attorney can also help you draft the agreement, and advise you regarding the wisdom of certain provisions (like a buyout agreement provision).
Your attorney can also help you draft and file the necessary paperwork with your state’s business registration department in order to get things set up and limit your personal liability for business debts.