What is a General Partnership?
General Partnership - A business arrangement by which two or more individuals agree to share in all assets, profits and financial and legal liabilities of a jointly-owned business. In a general partnership, partners agree to unlimited liability, meaning liabilities are not capped and can be paid through the seizure of an owner's assets. Furthermore, any partner may be sued for the business's debts.
There are several kinds of partnerships, but a general partnership is the most common and easiest to get started. It’s essentially the version of a sole proprietorship with more than one person. It is easy to start, no real formalities to file with the state and has simplified tax filings.
If you’re going into business with partners it’s important to understand what your options are, whether a general partnership will work with what you’re trying to do and what the advantages and disadvantages may be.
Advantages of a General Partnership:
Easy to Get Started
General partnerships are easy to get started as compared to the more formal business entities like an LLC or corporation. In order to have a general partnership there are a couple of things that have to be done or agreed upon:
- There must be more than one owner, and;
- All the partners must agree to unlimited personal liability for any legal liability or debt that the partnership may incur.
That’s it, so it’s pretty simple to get started: find another person, agree that you’re both liable for company obligations and you’re off and running.
Simplified Taxes
Businesses as partnerships do not have to pay income tax, they are treated as pass through entities. This means that profits and losses generated by the partnership are reported on the individual tax return of each partner, who then pays their personal income tax rate on any profits that are allocated to them. Unlike a corporation, a partnership does not get taxed as a separate entity.
Partners report their share of the company on a Schedule K-1, which will include a breakdown of their portion of profits or income; business deductions that are available; any gains that need to be reported and any losses.
Corporate Formalities
Like a sole proprietorship, there really aren’t any mandatory filing requirements or corporate formalities (state filings, record keeping, minutes, meetings, filings, etc.) necessary to get started.
Outside of sole proprietorships, most every other business type has some sort of corporate formalities that they have to abide by and that govern the operations of the company. With a general partnership you just need the partners to agree to get started with the goal of sharing the profits or losses and you’re in business, it doesn’t take any written authorization or filings to become official.
A partnership will still need to acquire the necessary business licenses or permits (these will vary by location) and will likely need to file for a fictitious name (DBA) with local government or the state.
Management Flexibility
Partnerships offer some flexibility in terms of management and company structure that isn’t available with other business entities. There’s the ability to split ownership, voting, decision making and other responsibilities in just about any way that works for the partners.
Partners have flexibility in deciding how to manage and run the business on a day to day basis. You can specify different responsibilities or areas to different partners, splitting up the management of the company, which can help the business operate more efficiently and accomplish goals at a faster pace.
The one thing that a general partnership can’t change is the joint and several liability, all general partners are equally liable for the debts of the business.
Shared Responsibility
One of the disadvantages that comes with starting a sole proprietorship is that everything is on a single owner to get accomplished. A general partnership is different, at a minimum there are two people involved in the business, and oftentimes more, which means there are multiple sets of hands to help divide up responsibilities.
This can make things a lot easier, especially in the early days when there’s lots of work to put in and little reward to see for it at the time. Having multiple people involved in the operations can lead to more ideas, more capacity and gives the business a bigger pool of talent, knowledge, networks and skills to take advantage of.
Disadvantages of a General Partnership:
Personal Assets Aren’t Protected
With no corporate structure, a general partnership doesn’t establish any corporate entity that is separate from the owners. This creates a problem, because it means that the owners personal assets can potentially be used to cover any debts or liabilities of the company. If the partnership has any unmet obligations, or has lost some litigation and owes money, then the owner's personal assets can be seized in order to cover any of those debts.
Joint Liability
This is a major concern for partnerships that is often overlooked. Every partner in a general partnership faces unlimited personal liability for three different things:
- Their own actions
- The actions of other partners that bind the partnership
- The actions of company employees
If someone sues a general partnership, the partners have shared responsibility for any damages that a judge or jury awards. This is called joint liability. Some states take this a step further with something called joint and several liability. In that case, a debtor or legal claimant can sue any partner for actions taken by other partners. It’s then the responsibility of the partners to sort out who owes what. Shared liability in a general partnership can be particularly harmful if one partner is negligent or involved in criminal activity.
The best way to illustrate how this works is probably an example. Suppose partners X,Y and Z own a construction company. One day on a job, partner X injures a client. The client sues all three partners and is awarded $1 million in damages. During the trial it comes out that partner X has no real personal assets. If this happens in a state with joint and several liability, the client can recover the $1 million from partners Y and Z, even though they had nothing to do with the accident on the job. Partner Y and Z can sue partner X to recover any money they had to pay the client, but they are unlikely to get much or any of it back since X doesn’t have any money.
Disputes
Disputes among partners can cause the business to fail, particularly in the absence of a partnership agreement, and even more so when the partners own equal shares, and don’t have a plan in place to handle split decisions.
The disadvantage here is the informal nature of this type of business entity. Each member's duties may not be clear to those who are in the partnership or to people outside of the arrangement. As a traditional general partnership involves each member having an equal responsibility and authority, there is the possibility that a single partner will end up committing the partnership to an agreement or course of action that all the partners didn’t agree on, leading to a dispute.
On top of that, if there isn’t a partnership agreement, or the agreement isn’t clear, additional disputes can arise over what partner is responsible for what part of the business.
Raising Money
Raising capital is difficult for general partnerships. Incorporated businesses can raise equity financing from angel investors or venture capitalists by selling shares of the business.
General partnerships can have a hard time securing loans, financing or capital compared to other types of business entities. It is more difficult for general partnerships to build business credit the same way that other companies can, since they often don’t have their own business credit cards and business bank accounts and can’t be separated from their owners.
Additionally, since all of the liability and backing for any financing usually comes from the partners, the entire business may be reliant on the partner’s finances, credit and investments. Personal loans are typically one of the most common ways general partnerships fund their business; just be aware that going that route will leave you personally liable for anything the business isn’t able to pay or defaults on.
Let's Sum It Up
General Partnerships have many advantages and are appealing to many entrepreneurs across numerous industries. It’s important to consider what type of business entity you will be when starting out, you can always change as you go, but it helps to get off to a solid start. Weigh the pros and cons with your particular situation and decide what’s best for you and take into consideration the other business entities that are available to you.
Ultimately, with a general partnership, any advantages around simplicity and ease of operations, will be outweighed by the potential risks (especially the joint and several personal liability).
Have questions about Partnerships or legal strategy in general? Contact us for a free consultation.