“Alone we can do so little. Together, we can do so much.” – Helen Keller
As we continue to look together at legal forms of small business ownership, today we will look at partnerships and their different forms. In the last blog post, we saw that sole proprietorships are quick and easy, but not usually the most prudent way to continue in the long run.
Partnerships are a definite improvement over sole proprietorships, and there are some choices to make in the type of partnership you choose. As the quote from Helen Keller says, there are reasons people enter into partnerships, not the least of which is the ability to accomplish more together than you can alone. But as for the legalities of business partnerships, there are many financial issues as well as other dynamics to consider. Let’s have a look.
There are three basic forms of business partnerships: General partnerships, limited partnerships, and limited liability partnerships. They each have their own distinct characteristics, advantages, and disadvantages.
A general partnership involves two or more partners operating a business, and each partner has equal rights and can obligate or bind everyone in the partnership to legal obligations. The main advantage is that a general partnership costs nothing to set up, and each partner reports his or her income as an individual. There are several downsides, and they are serious. The first is that a disagreement between partners can kill the business. Even more onerous is that any partner can do something with or without the permission or knowledge of the other, and the other is still responsible. How’s that for risk of liability? Also, a partnership is over if one of the members dies, retires, resigns, files for bankruptcy or just quits. If the partnership was running a successful business, the business ends right then and there – suddenly and unexpectedly.
Partnerships must have a well-thought-out partnership agreement. The agreement can try to address as many of these hazards as possible, but my experience has been that the agreement cannot possibly cover everything and as things, progress and change, something problematic will usually present itself that was not addressed in the agreement.
In limited partnerships, there must be two kinds of partners: general partners and limited partners. Limited partners are essentially investors. Investors are only liable for the total amount of their investment in the business. They are limited in liability for any debts, judgments or other liabilities of the business. General partners retain the rights to control the business, and limited partners do not have any right to participate in management decisions.
One distinct advantage of limited partnerships over general partnerships is that limited partners may leave the partnership without dissolving the business. These types of partnerships are well suited for real estate investment groups or the film industry.
Like all partnerships, limited partnerships have their weaknesses. If you are considering one, especially if you are going to be a limited partner, be very wise with your investment and choice of general partners. There is an old saying that at the beginning of a limited partnership, the general partners have the experience and the limited partners have the money. At the end of the limited partnerships, those positions are reversed.
Limited Liability Partnerships
Limited Liability Partnerships (LLPs) are typically formed for professionals such as lawyers, doctors, accountants and the like. One reason they do this in professional practices is that it insulates each partner from any potential malpractice of the other. Partners also take their share of losses or gains on their personal income taxes. Thus, they retain the tax advantages of the general partnership form but offer liability protection to the participants. Though partners are not liable for any malpractice by other partners, they still are liable for the debts or obligations of the business. This article from Entrepreneur.com gives you a more in depth view of Limited Liability Partnerships.
LLPs are regulated and taxed differently by various states, so do your research on the laws of your state regarding them.
For more information on forming partnerships and their pros and cons, check out this article from LegalZoom.
So, these are the three basic forms of partnerships to consider. Carefully weigh the advantages and disadvantages of each before you make your decision.