Many businesses start out as a "partnership", but not very often in the legal sense. It is not uncommon for 2-3 people to hatch a business idea and get the ball rolling with the intent of 'figuring it out later'. So if the idea takes off and 'later' arrives, is forming a real Partnership a good business structure?
What is a partnership?
A Partnership operates by an agreement by and between two or more people acting as co-owners of a for-profit business. For ease of use, Partnerships are often favored over other types of business arrangements. (See the "Other Business Structures" section below for other options.)
How is a partnership formed?
Creation, organization, and dissolution of partnership is governed by state law. Many states have adopted the Uniform Partnership Act. Most partnerships are created by the partners through the use of a written partnership agreement. Although a written agreement is the preferred method of forming a partnership, a partnership can either be express or implied with or without formal requirements (such as a signed document). To determine whether a partnership exists courts look at: (1) intention of the parties, (2) sharing of profits and losses (3) joint administration and control of business operation, (4) capital investment by each partner, and (5) common ownership of property.
How does a Partnership differ from a Corporation or Limited Liability Company?
Because the "persons" in a partnership can include individuals, groups of individuals, companies, and corporations, partnership are highly adaptable in form and vary in complexity. Unless the partners agree otherwise in the partnership agreement, each partner shares directly in the organization's profits and shares control of the business operation - this also means that the partners are jointly and independently liable for all of the partnership's debts. Much flexibility exists in a partnership, as the partners alone decide on how to run the partnership and how money will be divided.
Partners pay tax on the income generated by the partnership - and they share in the losses experienced by the partnership as well. The partnership itself does not pay income tax on earnings or deduct any losses - this income and loss is "passed through" the partnership to the partners. As such, partnerships, like limited liability companies and corporations that elect "S" tax treatment, are referred to as "pass through entities" for tax purposes.
Compared to a partnership, corporations and limited liability companies are more structured entities. In many ways, state laws and regulations detail or dictate the structure that a corporation or limited liability must have (i.e. corporations have officers and directors, must file formal formation documents with the state, must have by-laws or codes of regulations, etc.). As such, these two forms of business are considered more "structured" and "rigid" and more rules and regulations must be followed to establish and operate these forms of business. Further, corporations and, to some extent, limited liability companies, must also periodically filed certain documents with the state secretary of state and/or certain tax documents on an annual or periodic basis. However, both corporations and limited liability companies offer the shareholder or members of these business liability protection - meaning that in most cases, the corporation or the limited liability company is liable for its own debts and obligations and the shareholder or members cannot be required to pay these debts and obligations unless they agree to be personally bound to pay the same.
A downside to the partnership form of business is that each partner in a general partnership is personally liable for debts, obligations, torts or wrongdoings committed by the partnership and its agents. There is no liability protection offered to the partners through this business structure, like there is with a corporation or a limited liability company. Although a partnership does not offer the liability protection to the partners that a corporation can offer to its shareholders, partnerships tend to be less cumbersome, easier to manage from an administrative standpoint and require few, if any, document filings with governmental agencies.
OTHER BUSINESS STRUCTURES TO CONSIDER:
A for-profit corporation is a business organization formed for profit that is separate and apart from its owners (the owners are called "shareholders"). A corporation is a legal entity in its own right. As a separate entity, it has its own rights, privileges, and liabilities apart from the individuals who form it. Because the corporation is a separate legal entity in the eyes of the law, the shareholders are generally not personally responsible for the debts or obligations of the corporation. A stockholder's personal liability is usually limited to the amount of investment in the corporation and no more.
Limited Liability Company
A Limited Liability Company (LLC) allows for pass-through taxation similar to partnerships. All 50 states and Washington, D.C. have now adopted some form of LLC legislation. Many business professionals believe LLCs present an attractive alternative to corporations and partnerships because LLCs combine many of the advantages of both - many of the flexibilities of a partnership with the liability protection of a corporation.
This type of business is generally owned by a single individual or a several family members. A sole proprietor maintains and retains complete control of and responsibility for the business, receives all profits, is responsible for all loss, as well as all taxes and liabilities of the business. There is no liability protection offered to a sole proprietor and the persons engaged in this type of business are at risk of losing personal assets, even if the same are not part of the business. The primary advantage to this business is that there is little "official" paperwork required to start and run this type of business and decisions can be made quickly by the owners of the business.
As is stated above, in a limited partnership there must be at least one general partner who manages the business and who is fully and personally responsible for all claims against the partnership business. In addition, there are investors (i.e. the limited partners - known in the past as "silent" partners) who do not engage in the management of the business and whose liability for the business is limited to the extent of their investment into the business. Like a partnership, the liabilities and distribution of profits are based upon the agreement reached by all of the partners.
Limited Liability Partnership
A limited liability partnership has the same characteristics of a general partnership provided, however, none of the partners can be held personally liable for claims against the business. Under this form of business, each of the partners is generally not liable for the errors or negligence of the other partners unless they themselves are supervising, directing, or involved in the action for which a claim has been filed. As with a general partnership, profits are taxed as personal income for each individual partner. To obtain the benefit of the limit on the liability, this type of partnership must file articles or other appropriate documents with the state - in other words, it requires a formal filing to start this type of business.
Want to learn more about General Partnerships?
See our Q & A series on Partnerships at 'Ask Standard Legal' >
Ready to create a Partnership legal form?
See Standard Legal's Partnership Legal Forms Software here >
DISCLAIMER REGARDING LEGAL ADVICE: None of information contained on this web site is intended to constitute legal or other professional advice, and you should not rely solely on the information contained on the site for making legal decisions. When necessary, you should consult with an attorney for specific advice tailored to your situation.