When two or more people join forces to create a for-profit business, the result is a general partnership. A general partnership is an unincorporated business run by two or more people who are known as general partners. Although general partners may contribute differently to the enterprise, all are equally responsible for the partnership’s, profits, losses, debts and liabilities. Such an arrangement has many advantages and is one of the most common ways to structure a business. It also has some significant limitations compared to other business entities.
A financial advisor can help you create a financial plan for your business needs and goals.
General Partnership Advantages
Simplicity is the key attraction of the general partnership for business start-up. Among the different kinds of business structures, only the sole proprietorship is more straightforward than the partnership.
Unlike more complex entities such as corporations, little or no paperwork is required to create a partnership. At its most basic, an oral agreement with or without handshake will often suffice.
Partnerships often don’t have to file any paperwork at all with the states where they operate. If they do, it may be only to get a sales tax license. If the business will engage in an activity that is regulated by the state or local government, however, it may have to acquire a permit to operate.
Partners may forego hiring attorneys to prepare and review their agreement, if they even have a written one. That saves money on start-up costs, at the expense of some clarity that may result in confusion or disagreement later on. Ventures that begin as partnerships sometimes switch to a more sophisticated and well-documented structure such as a corporation later on.
Partnerships also take a straightforward approach to taxation. The partnership itself pays no income taxes. Instead, partners pay individual income tax on their share of the partnership profits.
If the partnership has run its course, it’s easy to dismantle it. If any or all of the partners want to leave the partnership, it can be dissolved by notifying federal and state tax authorities and informing any creditors and vendors of the partnership’s conclusion.
General Partnership Disadvantages
Liability is the Achilles heel of general partnerships. In a general partnership, each of the partners has unlimited personal liability for obligations the partnership incurs. That means if the partnership takes out a loan and doesn’t pay it back, creditors could go after the personal assets of any or all of the partners.
This is a key difference between general partnerships and corporations, limited liability companies and some of the other types of partnerships, including limited partnerships and limited liability partnerships. Corporations are legal entities separate from their owners. With general partnerships, there is no distinction between the business and the owners.
Another, potentially more bothersome, problem with liability in general partnerships is that each of the partners is liable for the actions of the other partners. This means if one of the partners executes an agreement in the partnership’s name, the other partners will have to honor it even if they knew nothing about it. This is an important reason for partners to be sure they trust one another fully before engaging in a partnership.
The liability issues make it more difficult to attract investors than would be the case with an entity such as a corporation that shelters owners from liability. This financial limitation can in turn limit the growth of the partnership.
How to Form a General Partnership
A general partnership can be formed orally and with just a handshake, but if you want to form one in a more formal way, there are as many as five steps to be taken.
Choose a business name. A general partnership’s name can simply be the surnames of the general partners.
File a fictitious business name. If you use a different name than the surnames of the general partners, check with the government of the state you are operating in about registration of that name. Make sure your name is distinct from other names and is actually available. Search your state’s database and the federal database to make sure a business name is available.
Draft and sign a partnership agreement. This agreement should specify what each partner’s contribution is; how profits and losses are allocated; each partner’s duties and authority; protocols for voting on key decisions; how new partners may be vetted and admitted; what happens in a bankruptcy or the death of a partner; and how to resolve disputes among partners.
Obtain licenses, permits, and zoning clearance. Check with state, county and local authorities about what your business needs.
Obtain an Employer Identification Number. Form SS-4 is a form from the Internal Revenue Service that you can use to apply for an Employer Identification Number.
Other Types of Partnerships
Different kinds of partnerships address some of the limitations of the general partnership. Limited partnerships, for instance, have two kinds of partners: general and limited.
The general partner in a limited partnership is responsible for managing the partnership and has unlimited personal liability for the business whereas the limited partners have only limited liability. They can’t lose more than the amount they invested in the partnership.
Another type, the limited liability partnership, doesn’t have a general partner; all partners are limited partners.
Each partner in a limited liability partnership participates in running the company. Each partner also has limited liability for the company. Many professional service businesses such as accounting and legal firms are organized as limited liability partnerships.
The general partnership’s ease, simplicity and avoidance of double taxation make it worth considering as a structure when two or more people go into business together. While the unlimited liability that burdens the partners is a significant drawback, partnerships are still among the most widely used business structure.
Tips for Forming a Business
- Many financial advisors specialize in advising business owners about their finances. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- At the other end of the spectrum from general partnerships are corporations. There are two kinds, S-Corp and C-Corp, each with its own advantages and disadvantages.
Photo credit: ©iStock.com/jacoblund, ©iStock.com/Dan Rentea, ©iStock.com/Drazen Zigic