Always seek out information pertaining to your jurisdiction before you make a decision.
The partnership is a common business structure when there are at least two owners of the business.
It is similar to a sole proprietorship when it comes to liablity and taxation, but can have more than one owner.
Each general partner can act on behalf of the partnership, e.g. sign contracts and incurr obligations, and this will be binding for the partnership and thus for the general partners.
In most jurisdictions, partnerships require more extensive paperwork to create and maintain compared to a sole proprietorship.
General partnership vs limited partnership
Many jurisdictions offer two types of partnerships:
- General partnership
- Limited partnership
All the owners manage the company and assume joint responsibility for the partnership’s liabilities, including debts and other obligations.
A limited partnership have both general and limited partners.
The general partners own and operate the business, and assume joint responsibility for the the partnership’s liabilities, including debts and other obligations.
The limited partners do not operate the business and their liability is limited. If you want to invest in a partnership, but want to limit your liability and are okay with not having the power to operate the business, then being a limited partner is a good choice. Your role would be similar to that of a shareholder in a corporation.
Compared to a general partnership, the limited partnership require more work to adhere to the laws regarding filings.
Taxes for partnerships
A partnership doesn’t pay tax on its income/profits. Instead, profits and losses are “passed through” to the partners who each indicate their share of partnership income, deductions and tax credits on their own tax filing and pay tax accordingly.
Even though the partnership doesn’t pay income tax, it must report its income on a separate informational return.
The partnership agreement
A written partnership agreement is used to state (and prove) the internal rules of the partnership.
When you start up a business together with someone, doing a partnership agreement can actually help you prevent problems later on since you will be forced to talk about issues that you might not have thought about before and ones that are tempting to not talk about during the “honeymoon phase” of starting a business.
It can be a good idea to seek legal counsel to create a well-written partnership agreement because poorly written partnership agreements are a feast for litigation attorneys when there is a conflict in the future.
Here are just a few examples of questions that should be ideally answered by your partnership agreement:
- What is each partners investment? Will any partner bring something else to the partnership than cash (e.g. equipment) that deserves consideration as part of the start-up investment?
- What are the responsibilities and duties of each partner? Instead of just writing down sweeping clichés here, take the time to outline each partner’s role in the day-to-day operations of the business.
- If a partner can no longer work, e.g. because of illness or injury, what will happen? Will the partner continues to receive a share of the profits, and if so, for how long? (This is usually a point that makes people start researching insurance options for the partnership and the partners.)
- What happens to the share if a partner dies?
- What happens if one partner wants to leave the partnership? (This talking-point usually results in the creation of a buyout agreement for the partnership.)
- Is a partner allowed to be involved in another business that is similar or competitive? Is there a difference between being a silent investor and being an active partner in such a business? How about a partner that has left the partnership; should there be a non-competitive covenant for a certain amount of time?
- Should a partner be allowed to transfer their ownership to anyone? Should the remaining partners be able to exert some kind of control over this? Should current partners have the first right to buy the ownership from a partner that wants to sell it?
- What happens if a partner gets divorced and his interest (co-ownership) in the partnership becomes a part of the divorce settlement? Rules that restrict partnership-interest transfers are often put in place to avoid this specific situation.
- Can a partner use his interest in the partnership as collateral for a loan?
- If the business needs a cash injection in the future, are all partners required to contribute the decided amount? What happens if someone can’t or refuses to?
- Should there be an arbitration process in place for conflict resolution?
Relationship to third-party
Please note that in many jurisdictions, the partnership agreement may not provide you as an individual with sufficient protection against actions carried about by another partner on behalf of the partnership in relation to a third party (e.g. borrowing money from a bank). This is because a third-party (e.g. the lender of money) can’t know what the partnership agreement says. They only know that you are a General Partnership and can not be held responsible for not knowing that you put into the agreement that Billy wasn’t allowed to borrow money or sign a 4-year-lease on expensive equipment. So, you will most likely end up being liable for the obligation. Still, the written partnership agreement will come in handy when you sue Billy for breach of contract.
If you need additional liability protection, there are other business entities that are more suitable than the General Partnership.