If you're going into business with someone, you might consider structuring your company as a general partnership. A general partnership is a type of business agreement between two or more individuals who agree to share all assets, profits, and liabilities of the business.
Because of its simplicity and tax benefits, a general partnership is one of the most common legal business entities. However, it's important to note that each partner is personally responsible for the business, including its debts and lawsuits, and is held liable for the actions of their partner(s).
Below we examine a general partnership's main benefits and disadvantages and outline whether this business structure is right for you.
[Read: 5 Steps to Starting a Business in a Few Hours]
What goes into a general partnership?
General partnerships are considered unincorporated businesses. Like a sole proprietorship, these business entities don't need to register with a state to function legally.
However, any solid business needs a few foundational elements to function, such as a partnership agreement, a management structure, and guidelines for compensation and decision-making.
A partnership agreement is not legally required, but it's helpful to have a document that outlines the rights and responsibilities of each partner. Likewise, general partnerships should have a management structure in place that outlines the following:
- The rights and responsibilities of the partners.
- The partnership's assets and liabilities.
- The financial responsibilities (fiduciary duties) of partners and the partnership.
- The voting rights and how profits will be allocated.
Financially, general partnerships usually receive capital contributions in the form of money, property, or services from the partners. Profits and losses are shared equally, though the partnership agreement can specify different allocations. Most importantly, the partnership itself does not pay taxes. Instead, profits and losses pass through to the partners' individual income tax returns.
Each partner is liable for the others' actions and debts, which makes it the riskiest part of starting a general partnership — it also means it's very important to know the people you plan to go into business with.
Benefits of a general partnership
Going into business with another person (or more) is advantageous. After all, two heads are better than one, and having a business partner can double your resources, availability, and reach. Here are three key benefits of a general partnership:
Easy to establish: Similarly to establishing a sole proprietorship, you don't need to file any forms with the state to start a general partnership; you only need a verbal agreement with your partners. Setting up a general partnership is relatively inexpensive because you don't have to file paperwork.
Simplified taxes: General partnerships benefit from pass-through taxation, where taxes on the business's profits or losses pass through the business entity directly to the business owners' personal taxes. Other business structures, like corporations, pay taxes twice — first on a business level and second on an individual level.
Easy to dissolve: If business owners must close their business for any reason, such as one partner filing for bankruptcy or one who wants to retire, dissolving a general partnership is easy. To dissolve the partnership, take the following steps:
- Notify federal tax authorities and your state.
- Submit a dissolution and liquidation form to the state where you do business. (This is not required but is a recommended precaution.)
- Alert all possible creditors of the dissolution so that you are not responsible for any additional debts.
- Let your customers and vendors know.
Disadvantages of a general partnership
Although general partnerships have strong advantages, there are disadvantages to consider before forming this type of legal entity. These are the two main disadvantages of a general partnership:
Personal assets aren't protected: Unlike corporations, general partnerships are not considered separate business entities. This means the partners are not protected from lawsuits brought against the business. Additionally, personal assets may be seized to cover unpaid debts.
Partners are liable for each other: Each partner is liable for the others' actions and debts, which makes it the riskiest part of starting a general partnership — it also means it's very important to know the people you plan to go into business with.
What are some examples of general partnerships?
More businesses than you may realize function as general partnerships. Classic examples include professional services, such as law firms, medical practices, and accounting firms. For instance, groups of doctors often form general partnerships to run a joint medical practice.
Creative agencies or real estate groups also can operate as general partnerships. Design studios may bring together graphic designers or architects under a general partnership to combine their talents and client bases. Likewise, realtors may partner to create a joint real estate brokerage.
"General partnerships have been the business entity of choice for individuals seeking to work together as well as various types of service providers," wrote Investopedia.
Is a general partnership right for your business?
If you are going into business with another individual you know and trust, a general partnership might be a good solution for your business. Professionals like general partnerships because of how simple they are to set up.
Assuming you already have a business partner you trust, you can get started immediately with a general partnership. A verbal agreement is only required between partners (although a written partnership agreement is recommended). In addition, filing forms with your state is not required, and you won’t have to pay any corporate taxes due to the pass-through structure.
As great as a general partnership can be, it comes with risks — mainly liability. If you make any mistakes, such as incurring debt, you and your partner(s) are liable. Likewise, if your partner does anything negative without your permission, such as signing an agreement with a software company, you are obligated to fulfill the terms of the agreement.
Ultimately, the business structure you choose depends on your relationship with your potential business partners and how much liability you are willing to take on.
[Read: Getting Ready to Launch? How to Choose the Right Business Structure]
This article was originally written by Sean Peek.
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