Just as a sole proprietorship is an unincorporated business entity operated by a sole owner, a general partnership is an unincorporated business entity operated by two or more business owners.
A general partnership is created by default between two or more people. Other business structures like the corporation, limited liability company, limited liability partnership, or limited partnership are created with a state. A general partnership operates with all of the partners holding equal rights to manage and control the business. This is true unless there is a partnership agreement in place, which is a verbal or written agreement between the owners of the business. A verbal agreement can be used but is much harder to defend than a written partnership agreement should there be a disagreement.
Each of the general partners has the same power, ability to make business decisions, and authority to control and obligate the business, and most importantly, there is no limited liability protection afforded through this entity.
Main Advantages of a General Partnership
Operating as a general partnership can have many benefits, including the following:
- Easy creation: Since this type of entity is established by default without filing any paperwork, you can get your business up and running right away without worrying about completing the correct forms and paying fees to your state. However, each state has different requirements for licenses, permits, and registration of fictitious names with which the partnership will need to comply.
- Financial ease: Like sole proprietorships, profits and losses flow directly through the business to the personal finances of each general partner. The division of the profits and losses can be different, but there is no obligation to establish each partner as an employee of the company.
- Flexibility: Partnerships are incredibly flexible and lend themselves to a variety of options in regards to partner responsibilities, voting rights, and profit-sharing.
- Limited tax obligations: The partnership is not liable for income taxes as a separate entity. Much like a sole proprietorship, a general partnership is considered a pass-through entity and is taxed through the partners’ individual taxes.
Main Disadvantages of a General Partnership
- Unlimited personal liability: one of the biggest pitfalls of operating as a general partnership is that every partner has the ability to bind the business and the other partners for business obligations or business debts. If someone files a legal action against the partnership, each partner will be held personally liable for any judgments to creditors. This is of particular concern if one partner acts negligently or fraudulently when acting in their business capacity as the personal assets of all the general partners may also be at risk.
The unlimited liability of general partnerships is usually the biggest reason to choose a corporation or LLC as it helps to shield the owner’s personal assets. Learn more about forming an LLC.
- Easy to dissolve: A general partnership can be dissolved at any time. Without a written agreement in place, the business will be dissolved upon the occurrence of a number of events, such as death or a partner leaving.
- Taxation: The partnership itself pays no taxes. The profits of the partnership go to the partners income tax return through the Schedule K-1. All profits are subject to self-employment taxes. Depending on the amount of profits, there may be a tax savings by forming a corporation or LLC and electing to be taxed as an S Corporation.
How to Form a General Partnership
As discussed above, no formal actions are required in order to create a general partnership. However, establishing a general partnership agreement between the partners is highly recommended. Having an agreement in place will prevent disagreements and stipulate the rules that each general partner needs to comply with.
This agreement should cover a number of provisions relevant to business operations, including the following:
- Names and addresses of all partners
- Titles and responsibilities of each partner
- The legal name of the business
- The effective date of the partnership and intended duration
- Voting rights for each partner
- Voting procedures
- Procedures in the event that a partner dies or leaves the business
- Dissolution voting procedures
- Distribution percentages for partners
- Required contributions of partners
Related: How to Write a Partnership Agreement.
After the partnership is formed, the next step is to register for an Employer Identification Number (EIN). The EIN is a unique number created with the Internal Revenue Service (IRS) to identify a business (much like a social security number does for an individual).
It is important that you carefully consider the people you start a general partnership with, especially considering the liability issues for you and everyone else involved. You will want to start a partnership with people you can trust to adhere to the provisions of the partnership agreement and to not take actions that will expose the business to adverse legal actions.