Last Updated on September 2, 2020
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 a legal entity created between two or more people. Other business structures like the corporation, limited liability company, limited liability partnership, or limited partnership are business entities created with a state. A general partnership operates with the business partners holding rights to manage and control the business.
Each of the business partners has equal power and ability to make business decisions, and authority to control and obligate the business to contracts while having shared liability for partnership debts and obligations. (referred to as joint liability)
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 any filing 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.
Unless the partnership intends to operate under the full first and last name of the partners, a DBA or Doing Business As (also known as an Assumed Name, Trade Name, or Fictitious Name) will need to be filed. See how to register for a business name
- 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 offer a large amount of flexibility 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 has pass through taxation, which means the profits of the business are taxed through the partners’ individual income tax rates.
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 the full amount to 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.
- 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 partner’s personal 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 individual 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
- Partnership interest
- 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).
While not required, it’s vitally important to create a partnership agreement. The partnership agreement 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.
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.