There are two types of partnerships: general partnerships and limited partnerships. A general partnership is created when two or more individuals agree to create a business and to jointly own the assets, profits and losses. A limited partnership may be created only by following certain steps set out in each particular state’s statutes. The primary advantage of partnerships is that they can have more than one owner; the most important disadvantage is that the general partners are personally responsible for the losses and other obligations of the business.
Start by Agreeing
You can start a general partnership by agreeing with one or more individuals to jointly own and share the profits of a business. There is no limit on the number or type of partners (i.e., individuals, other partnerships or corporations) you may have in your business.
A general partnership is deceptively easy to start because it can be formed by an oral agreement. However, it is advisable to have a written agreement signed by all partners addressing major issues relating to the business, including
- How much time and/or money the partners will contribute to the business.
- How business decisions will be made.
- How profits and losses will be shared.
- What will happen to the business and to a partner’s share of the business if that partner dies, becomes disabled or stops working/contributing to the business.
- How long the partnership will exist.
- When the partnership will make distributions (i.e., payments of income earned based upon partnership share) to its partners.
A limited partnership consists of one or more general partners (i.e., those who are generally liable for the business) and one or more limited partners (i.e., those who have limited liability). If the statutory requirements are not followed, a limited partnership will be treated as a general partnership; therefore, it is important that you consult with an attorney in creating a limited partnership.
Selecting a Name/Filing Certificates
As with the sole proprietorship, partnerships often use the name of the partners as the name of the business. If all the partners’ names are not used, or if none of the partners’ names are used, you may have to file a “fictitious name” certificate. A number of states require partnerships to file partnership certificates either with the local government or in the office of the secretary of state or its equivalent. Check with your local government office to determine whether your state has such requirements.
The partnership should keep separate bank accounts and financial records for the business so the partners know whether there are profits and losses, and how much of either they receive.
Who Owns the Business?
The partnership agreement should state what percentage of the business and profits each partner will own. In the absence of an agreement, each partner will own an equal portion of the business and profits (as well as the liabilities) of the business.
Who Controls the Business?
The partnership agreement should specify who will control and manage the business of the partnership. In the absence of an agreement, all general partners have equal control and equal management rights over the business. This means that all of the partners must consent and agree to partnership decisions. It is important to note, however, that any partner can bind the partnership and the individual partners to contracts or legal obligations, even without the approval of the other partners.
In a limited partnership, the management and control of the business is handled by the general partners. State law restricts the types of control and management the limited partners can undertake without jeopardizing the limited partnership’s existence.
A general partnership has characteristics of both a separate legal entity and a group of individuals. For example, it can own property and conduct business as a separate legal entity. However, the general partners are “jointly and severally” liable for the partnership; i.e., all of the partners are liable together and each general partner is individually liable for all of the obligations of the partnership. This means that a creditor of the partnership could require you individually to pay all the money the creditor is owed. Your partners would then reimburse you for their share of the debt or loss. Before you decide to join a general partnership, determine whether your partners can financially afford to share the losses of the partnership. If you are the only partner with any assets or money, the creditors of the partnership can require you to pay them, and you will be unable to get reimbursement from your partners.
Limited partners do not have personal liability for the business of the partnership. Limited partners are at risk only to the extent of their previously agreed-upon contributions to the partnership.
Continuity and Transferability
How Long Does a Partnership Last?
A partnership exists as long as the partners agree it will and as long as all of the general partners remain in the partnership. If a general partner dies or leaves the partnership, the partnership dissolves and the assets of the partnership must be sold or distributed to pay first the creditors of the partnership and then the partners. The partnership agreement may provide for the continuation of the business by the remaining partners, in which case it may not have to be sold upon the withdrawal of a general partner. When a general partner leaves a partnership, he or she is entitled to an accounting that will determine his or her share of the assets and profits of the partnership. The agreement should also cover how a partner will be paid for his or her share of the partnership when he or she leaves or dies.
Can a Partner Sell His or Her Share of the Partnership?
The partnership agreement should state whether a partner can sell his or her partnership share. In many states, the sale or transference of a partnership share cannot take place without the consent of all the other partners. Even if a partner does transfer a share of the partnership, he or she will remain personally liable for the business losses incurred prior to the sale of that interest.
The partnership itself is not responsible for paying taxes on the income generated by the business. A partnership tax return is filed, but for informational purposes only. Instead, each partner individually pays taxes on his or her share of the business income. The profits and losses “flow down” from the partnership to the individual partners. (Recent changes in the tax law may restrict the use of partnership losses to offset income of the partner generated by activities outside of the partnership. Consult a tax advisor about these matters.) In certain cases, a partner may be required to pay tax on income from the partnership, even without having received any of the income. Partners must also pay self-employment tax on their partnership income.
Pros and Cons
- Is a very flexible form of business.
- Permits ownership by more than one individual.
- Avoids double taxation.
- Has few legal formalities for its maintenance.
- Partners have unlimited personal liability for business losses.
- Partnership is legally responsible for the business acts of each partner.
- General partnership interest may not be sold or transferred without consent of all partners.
- Partnership dissolves upon death of a general partner.