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Here we’ll break down what a general partnership is, whether it’s the right business entity type for your business, and how to form one properly.
What is a general partnership?
A general partnership is an unincorporated business run by two or more people, where each partner has equal control of the business and each partner is equally liable for the debts of the business.
People use this business structure because it’s the quickest, easiest way for two or more people to go into business with one another.
The mom and pop laundromat down the street from your apartment is probably a general partnership. The house painting business you started that one summer in college with a friend was also probably a general partnership, even if you didn’t file any paperwork or officially declare it to be one.
You might be part of a general partnership right now without even knowing it!
What is liability?
Most of the risks involved in starting a general partnership boil down to liability, which is what lawyers call the responsibility that each of the partnership’s owners has over the business’ debts.
If you go into business as a sole proprietorship, for example, you’re only on the hook for your own debts.
General partnerships involve multiple people with shared liability, which means that you’re on the hook for someone else’s personal liability. If they make a mistake, it affects you directly.
People often form business partnerships with close friends and loved ones, and disagreements between partners are inevitable. So it’s clear that this isn’t a process that you want to rush or seal with just a handshake.
How do I form a general partnership?
You don’t technically need to file any forms with your state to start a partnership. In most states, all you need to start one is a verbal agreement and a handshake.
But not getting the terms of your agreement down in writing could get you in trouble if there’s ever a legal dispute between you and your fellow other business owners, which is why it’s always better to write up a partnership agreement.
Sign a written partnership agreement
Small businesses will often “wing it” and stick to a verbal agreement. After all, you’re going into business with someone you trust—what could go wrong?
The answer is: a lot. No matter how much you trust your business partner, you need to get everything in writing. And to do that, you need to sign a written partnership agreement.
A partnership agreement is a lot like the bylaws of a corporation. At minimum, it should establish four things:
- The name of the partnership
- How the profits of your partnership will be distributed
- How its losses will be shared
- What happens when someone wants to sell or get rid of their stake in the partnership
A well-written, exhaustive partnership agreement should also cover:
- The nature of your business
- How long the partnership will last (if it has an expiry date)
- What kinds of partners it will contain (more on that below)
- What each partner is expected to contribute in terms of capital, time and resources
- Rules for what happens when it’s time to dissolve the partnership
- How disagreements should be resolved
LawDepot’s handy partnership agreement generator should give you a sense of what goes into a typical partnership agreement.
As tempting as it might be to write one up yourself, never sign a partnership agreement without first having a lawyer look at it.
A lawyer can help you craft a partnership agreement that fits your business’ specific needs, anticipates any problems your business might run into later, and save you a lot of trouble if you or one of your partners ever decide to sue one another down the line.
How are general partnerships different from the other business entity types?
General partnerships are different from the other three other kinds of business entities you can form with multiple partners: limited partnerships, limited liability partnerships, and corporations.
Limited partnerships
Limited partnerships have at least one partner called a limited partner who isn’t liable for the debts of the partnership and who doesn’t have any control over the day to day business decisions or management of the company.
Also sometimes called silent partners, limited partners usually only contribute money to a business and stay out of the day to day dealings of the company. Their liability is limited to the amount of their initial investment.
For example: let’s say you’re a limited partner in your friend’s A.I.-powered dog grooming startup, which you’ve invested $2,000 into. If your friend ever goes bankrupt, creditors can only come after you for that $2,000 equity stake. The rest of your assets are protected.
Limited liability partnerships
Limited liability partnerships (LLPs) have at least one limited liability partner, who is like a limited partner that also participates in the day to day management of the company. In that way, they’re similar to a member of a limited liability company (LLC).
Corporations
The one other kind of business entity you can start with multiple people is a corporation, where no one is liable for the debts of the company.
Why form a general partnership?
People form general partnerships for two main reasons:
They’re easy to form
Like we mentioned earlier, you can form a general partnership with a simple verbal agreement. Compared to incorporating or forming an LLP, establishing a general partnership is cheap, fast and easy.
Forming one could lower your tax bill
Partnerships are taxed as “pass-through entities.” This means any profits you make as a general partner become personal assets, and get taxed by the IRS at your personal income tax rate. When you file your tax return, you could end up with a lower tax bill than the one you’d get if you incorporated.
Downsides
This type of business isn’t for everyone. If the following are deal breakers for you, you might want to consider a different business entity type:
You’re on the hook for someone else’s debts
General partners and general partnerships are exposed to more liability than any other kind of partner or business entity—more than sole proprietors, even. If one of your partners screws up and puts the business into debt, their creditors can come after you for the full amount, even if you had nothing to do with taking on that debt in the first place.
You’re on the hook for any other mistakes they make too
If you’re a general partner, you might also be liable for any negligence or malpractice committed by your partners or employees over the course of their work. You can buy general liability insurance to counteract some of this risk, but you can never completely eliminate it.
