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 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.
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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 secure business needs a few foundational elements to function seamlessly, 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.
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: Similar 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 a C corporation, 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 it 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.
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.
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 and trust 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 medical practice.
Creative agencies or real estate groups can also 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.
"Many individuals and service providers choose general partnerships because they are simple, low-cost, and easy to set up," 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 without your knowledge, you are obligated to fulfill the terms of the agreement.
How does a general partnership compare to an LLC or S corp?
First, let’s establish some key characteristics of these two business entities. Owners of limited liability companies (LLCs) and S corporations enjoy limited liability protections, meaning they are not personally responsible for the business’s debts and liabilities.
LLCs and S corps are separate legal entities created by a state filing and subject to certain state compliance requirements. They are considered pass-through tax entities. That means all taxes are reported and paid on individuals’ tax returns.
As we’ve established, general partnerships don’t offer liability protection, do not have to be registered with the state, and don’t have state-level rules to comply with. General partnerships are similar to LLCs and S-Corps in their taxation: Each is a pass-through entity.
Other key differences relate to ownership and management. For example, LLCs can have an unlimited number of members; S corps can have a maximum of 100 owners. In regard to management, an LLC functions more closely to a general partnership.
“Owners of an LLC can choose to have members (owners) or managers manage the LLC. When members manage an LLC, the LLC is much like a partnership,” wrote Wolters Kluwer. “S-Corps have directors and officers. The board of directors oversees corporate affairs and handles major decisions, but not daily operations. Instead, directors elect officers who manage everyday business activities.”
At a high level, a general partnership is a good option for partners who need something informal, low cost, and who are comfortable taking on the personal liability.
An LLC is the right fit for those who want liability protection, flexible ownership, and simpler administration. LLCs can also elect the S corp taxation structure later, if self-employment tax savings outweigh the extra complexity of setting that structure up.
S corps are ideal when the business is profitable enough to pay reasonable salaries to owner‑employees and still distribute additional profits in a tax‑efficient way.
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 more: Getting Ready to Launch? How to Choose the Right Business Structure]
Steps to legally form a general partnership
Forming a general partnership is usually very simple. In most states, it legally exists as soon as two or more people agree to run a business for profit. But you still need to take several steps to operate properly and comply with tax and licensing rules. Exact requirements vary by state and city, so check the local rules or talk to a professional before finalizing anything.
Here are a few legal steps you should take to make your general partnership more official and comply with tax and licensing rules.
- Choose a business name. Most unregistered general partnerships choose to operate under the partners’ last names. However, you can choose a “doing business as” (DBA) name if you want something a little more interesting. DBA names need to be registered with the state.
- Get an EIN number. A federal employer identification number (EIN) is needed to file your partnership return with the IRS each year. Bear in mind that your local and state governments might require additional tax identification numbers, so check their tax requirements too.
- Get the required licenses and permits. “Your license obligations often depend on the nature, location, and characteristics of your business. However, some states and cities require all businesses in their territory to have a general business license. Many business licenses require payment of filing fees and regular renewal,” wrote ZenBusiness.
Other documents, such as a business plan or partnership agreement, aren’t legally required. They are useful for keeping your business organized, as well as for when you need to open a business bank account. Lenders and investors like to see founding documents that add legitimacy to your general partnership.
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