Business Planning 101 – Entity Formation – General Partnership
Last week I begun our Business Planning 101 – Entity Formation series focused forming a new venture a as a sole proprietorship. Today I will focus on another entity choice for your business, the basic form Partnership often referred to as a General Partnership. It is important to note there are other special partnership forms including, Limited Partnerships and Limited Liability Partnerships. We will discuss these additional entities in future blogs as both require registration with the state.
So, what is a partnership? In the simplest of terms a partnership is an association of two or more competent persons to carry on as co-owners a business for profit.* Like a sole proprietorship, there are no formalities required to form a general partnership. Often partnerships are created expressly through words or writings (Partnership Agreement), but a partnership can also be implied through conduct of the parties.**
There are several benefits to establishing a company as a partnership. First, there are no requirements to file forms or pay filing fees with the state agency that handles business filings (in the case of Massachusetts, the Secretary of State). Second, there is no taxation to the business itself because a partnership is known as a “pass through” entity meaning all income, deductions, and credits pass through to the individual tax payer as personal income and owners pay taxes according to their individual tax rates. Another potential taxed based benefit of a partnership is the opportunity for profit and loss splitting which is an advantage for some tax payers.
Other benefits of partnerships include potential injection of cash or connections to liquidity. A partner can reduce financial burden for expenses and capital expenditures needed to run the business. A partner can also bring additional business opportunities to a business by freeing up time or bringing their own connections. Last but most certainly not least, a partner can bring much needed moral support and a feeling that you are not going into a venture alone.
Partners share control and all significant decisions are made jointly which can be both a hindrance or benefit depending on one’s personal opinion. I personally believe one of the most important benefits of a partnership is the value added to decision making by another partner’s knowledge, experience or skills that a sole proprietor would not have alone. However, this collaborative benefit is a double edged sword because what you gain from another’s input you can loss in autonomy.
With all of those benefits one can see why there are so many partnerships across America, but it is important to remember that in addition to lack of autonomy there is one significant disadvantages to general partnerships. Partners of a general partnership, similar to sole proprietors, are personally liable for the business debts and liabilities, even if they are incurred by the other partner. A partner’s liability may be retroactively reduced by indemnification, a process in which one partner makes the other whole for expenses he pays due to a partnership expense or liability. (Because indemnification can be complex and deserves its own blog, we will cover it in future blogs.)
There is no question that there are benefits of a partnership and it is highly recommended that entrepreneurs, investors and business people collaborate in ventures due to financial and creative value additions. If you chose to enter into a general partnership I do recommend that due diligence is completed and a written partnership agreement is drafted to mitigate some of the smaller disadvantages.
As stated above, partnerships can be a wonderful thing, however, I would be remiss if I did not say that due to the unlimited joint and several liability general partnerships should be discouraged. If you want the collaborative benefits of a partnership other it would be wise to consider another entity form such as a Limited Liability Company, Limited Partnerships or Limited Liability Partnership to carry on as co-owners of a business for profit with two or more persons.
If you would like further guidance on starting your next venture please contact Lake Shore Legal at email@example.com
Next week we will discuss the positive and negative aspects to forming a C – Corporation.
* It is important to note here that a “person” creating the partnership may be an individual, partnership, corporation or LLC. **Due to the lack of formality, courts often need to determine the existence of partnerships. If the intent is not expressed, look to: Title to property, designation of entity, amount of activity involved, sharing of gross returns, sharing of profits, sharing of losses. The most important determination used by courts is the sharing of profits, if sharing of profits occurs it is presumed by the courts that a business is a partnership.