What Is A General Partnership?
A general partnership is a voluntary association of two or more persons who operate a business for profit as co-owners. From a legal point of view, the business partnership and its owners are separate legal entities, but are treated almost as if they were one and the same. Any number of members can be part of a partnership, though they are very hard to operate with more than two or three members. Like a sole proprietorship, there is little paperwork involved in the actual formation of a partnership. Due to the nature of this business structure, however, every general partnership should start with a solid partnership agreement laying out the details of how the partnership will operate.
Is A General Partnership Right For Your New Business?
- Easy business structure to form
- High level of privacy for owners
- More start-up capital than sole proprietorships
- More diversity of skill-sets than sole proprietorships
- Ability to divide labor based on individual abilities of partners
- More able to obtain credit than sole proprietorships
- Beneficial pass-through taxation of profits
- Difficult to terminate if any partner does not wish to do so
- More difficult to operate than a sole proprietorship
- Disputes between partners can lead to impasses and harm the business
- All partners are legally bound by the actions of any other partner
- All partners have unlimited personal liability for damages caused by any other partner
- Business owners bear 100% of losses
- Difficulty in selling the business, as the business and its owners are one and the same
- Automatic dissolution upon any owner's death unless special arrangement stipulated in operating agreement
- Partners who do not fulfill their responsibilities may still be legally entitled to 50% of the partnership's profits
Of all the drawbacks of operating a general partnership, unlimited personal liability for all of the partners is the most severe. If a lawsuit is filed against the business or any of its partners, both the business assets and the personal assets of all partners can be taken by the courts to settle the suit. There is no legal recourse to limit this liability, nor is there any way to obtain bonding protection from the actions of other partners.
Because general partnerships face so much liability, anyone operating as a partner should absolutely carry a sizable liability insurance policy before doing business. In today's incredibly litigious environment, an umbrella policy worth several million dollars would not be excessive. Running a business without liability coverage is known figuratively in the business world as running naked, and it is every bit as ill-advised as is its literal counterpart.
Because all general partners are directly responsible for the legal and civil woes of the partnership, anyone who enters into a general partnership should make sure to always have access to competent legal counsel. While this is true of any business, it is especially true in sole proprietorships and partnerships, where there is no liability barrier between the owner and the business.
How To Form A General Partnership
In its simplest form, creating a general partnership is only slightly harder than forming a sole proprietorship. Two persons agreeing to operate a business together is all that is legally required. Every partnership should, however, begin with a solid operating agreement between the partners to ensure that the business operates smoothly.
Without an operating agreement, all general partnerships operate under the default rules of the Uniform Partnership Act. The provisions of the UPA only apply in the absence of other expressed agreements, though, so partners may create specific operational rules in their operating agreement that will take precedence over the UPA. Among other things, this act stipulates that all partners split any profits and losses evenly, even if some partners do more of the work, and that all partners have an equal amount of control over the decisions of the business.
Partners should decide at the outset several things about how the partnership will operate. It is highly advisable that one partner be stipulated to have 51% control over the partnership. While many people feel that it is only fair that partners have an equal voice in running the business, arguments are common in almost every business. If neither partner has a controlling interest, and impasse can occur. Such impasses can, and regularly do, cause partnerships to lose money or even fail.
If profits, losses, and responsibilities within the business are not going to be split equally amongst all partners, this must be specified in the operating agreement. While the verbal agreements are technically considered legally binding, it is virtually impossible to prove the verbal agreements exist within a court of law. Getting such agreements down in writing is therefore very important.
Another thing to consider in the operating agreement is what happens upon the death of a member of the partnership. By default, the death of one of the partners legally terminates the existence of the business. Legal action is then needed to revive the business. This can easily be overcome, however, by stipulating that any remaining partners can purchase the interest of the deceased partner.
A buyout clause within the operating agreement is also a good safeguard against the failure of the business should be partners become incompatible. One partner, for example, could be given the option to purchase the other partners' interest in the business at fair market value as a means of terminating the partnership. To ensure fairness, such a clause should be agreed upon at the very outset.
What To Expect
While the formation of a general partnership is easy, actually operating such a business may be much more complicated. There may be many rules and regulations that apply to the partnership depending upon the nature of the business. Many kinds of services require licensing, such as construction trades, food service, cosmetology, etc. It is up to the business partners to determine what legal requirements must be met during the operation of the business.
Working with a partner can be difficult. Partners must maintain good communication, and any orders given to employees of the partnership need to be consistent to prevent confusion over what needs to be done. All partners need to ensure that they are fulfilling their own duties, and that all other partners are fulfilling theirs.
The most common tax forms filled out by members of a general partnership are:
- Form 1065 K-1: Partner's Share of Income, Credit, Deductions
- Form 1040: Individual Income Tax Return
- Form 1040-ES: Estimated Tax for Individuals
- Schedule C: Profit and Loss from Business
- Schedule E: Supplemental Income and Loss
- Schedule SE: Self-Employment Tax
- Form 4562: Depreciation and Amortization
- Form 8829: Expenses for Business Use of Your Home
- Employment Tax Forms