A partnership business is one of the simplest structures that allows two or more individuals to co-own a business.
In this article, we look at various aspects when forming two partnership types — a general partnership and a limited partnership — including pros and cons, how responsibility is shared, and what to include in a partnership agreement.
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What is a partnership?
A partnership is a type of business structure where two or more people or entities own a business. There are four partnership types: general partnership, limited partnership, limited liability partnership, and limited liability limited partnership.
- General partnership. In a general partnership (GP), two or more people come together to share the responsibilities, assets, profits, and liabilities of a business. This means that each partner is personally responsible for the business's debts and obligations, without any limits on their liability.
- Limited partnerships. In a limited partnership (LP), there are two types of partners: general partners and limited partners. General partners run the business and take on all the liability for its debts. Limited partners, on the other hand, are like shareholders in a corporation. They don't manage the business but can decide who does. They share in the profits, but their losses are capped at the amount they invested.
- Limited liability partnership. The LLP is a structured format in which all partners enjoy limited liability and are allowed to take part in managing the partnership. It necessitates a written partnership agreement and often has annual reporting obligations, which may vary based on your legal jurisdiction.
- Limited liability limited partnership. A limited liability limited partnership (LLLP) includes one or more general partners who oversee the business activities and limited partners who hold a financial stake in the entity. It’s important to note that not all states acknowledge the existence of LLLPs.
For more information, read Comparing partnership types.
Forming a general partnership
If your business is going to be owned by more than one owner, the simplest business form to create and operate is a general partnership. Although a partnership is more complicated to form than a sole proprietorship, it is not as complicated as a corporation.
The flexibility of a partnership allows your business to operate in a manner that best suits the business needs at the time you start the business and later when the business has matured. For example, when your business is just beginning, one partner may have skills that are valuable to the business, but little capital. Another partner may have capital, but not the requisite skills. The partner with skills can contribute services to the partnership while the other partner contributes capital.
Later, when your business has grown, new partners can be admitted, yet their management capacity can be limited to prevent the new partners from usurping the original partners. When a partner contributes capital to a partnership, the partner receives an ownership percentage in all assets of the partnership, not just in the property contributed.
Advantages of a general partnership
- Multiple owners. A partnership can have more than one owner, unlike a sole proprietorship.
- Simplicity. A partnership is easy to form and operate.
- Flexibility. A partnership is flexible enough to adapt to the business’ changing needs.
Disadvantages of a general partnership
- Unlimited liability. Each partner is jointly and severally liable for all obligations of the partnership.
- Dissolution. A partnership dissolves upon the death or withdrawal of a partner unless safeguards are in place.
General partnership liability
All partners in a general partnership are “jointly and severally liable” for the obligations of the partnership. This means that each partner can be held responsible for all partnership obligations. For example, if a plaintiff is awarded a monetary judgment against multiple parties, they can recover the entire amount from any single one of those parties.
Note: In a general partnership, any partner can enter into a contract on behalf of the partnership. By doing so, a partner can bind all partners in an unfavorable contract, since all partners are jointly and severally liable for the obligations of the partnership.
LLCs shield owners from personal liability related to business debts and legal actions. This helps protect the personal assets of all owners. For more information, see LLC vs. partnership.
How is a general partnership created?
Forming a partnership entails an agreement between two or more prospective partners. The agreement can be oral but should be written and signed by all partners to avoid later conflicts. Virtually anyone can be a partner. A partner can be an individual, a partnership, a limited liability company, a corporation, or a trust.
The partnership should obtain a federal employer identification number, which is issued by the IRS.
The partnership will also need to complete the necessary license and permit requirements. These may range from occupational licenses to general business license registration. If your business operates under a name that is different from the owner's name, most jurisdictions will require that a DBA (doing business as) filing be made. This informs the jurisdiction that the business is operating under an assumed name and indicates the name of the business owner(s).
General partnership agreement
The partnership agreement is a complicated document that should be drafted by an attorney. At a minimum, address the following subjects in the partnership agreement:
- Contributions. The amount and time of contributions to be made by each partner should be specified.
- Management and control. Identify whether some or all partners will manage and control the partnership.
- Profit and loss. Specify how the profits and losses will be allocated to the partners.
- Distributions. Indicate when distributions of cash or property will be made.
- Partner's responsibilities and duties. Describe each partner's responsibilities and duties.
- Withdrawal. Identify how a partner's interest will be valued if the partner withdraws from the partnership.
- Death. Identify how a partner's interest will be valued if the partner dies.
Additional topics to be included in a partnership agreement, if applicable:
- Admission of new partners. Indicate the process for admitting new partners into the partnership.
- Right of first refusal. Specify that the partnership or individual partners will have the right to purchase a withdrawing partner's interest before the partner can offer to sell the interest to someone outside the partnership.
- Duration of the partnership. Indicate the life of the partnership along with any events that may cause the partnership to dissolve prematurely.
- Continuation of the partnership. Identify the criteria to enable the partners to continue the partnership if an event causing the dissolution of the partnership occurs.
Forming a limited partnership
A limited partnership is a partnership with two classes of partners: general partners and limited partners. The general partners operate the business and are personally liable for all obligations of the partnership. The limited partners do not have any control over the business, other than determining who will manage the business. Limited partners share in the profits of the partnership, but their losses are limited to the amount of their contributions to the partnership.
There are some situations in which a limited partnership for a new business may be desirable. One such instance is a business in which the owner needs to raise capital yet still controls how the business is operated. If that applies to you, you might consider forming a limited partnership and selling limited partnership interests to investors.
Advantages of a limited partnership
- Protection for owners against personal liability for business obligations and lawsuits, ensuring that their personal assets are safeguarded.
- Limited partners are not subject to self-employment taxes.
Disadvantages of a limited partnership
- General partners face unlimited personal liability.
- Limited partners are prohibited from making management decisions.
- Transferring ownership can be challenging.
- Additional filings and administrative complexities (compared to general partnerships).
Note: LLC owners are protected from personal liability for the acts of the LLC and the other owners. It also offers many options when it comes to its management structure. For more information, see LLC vs. partnership.
How is a limited partnership created?
To establish a limited partnership, the partners must register the business in the appropriate state. Generally, a certificate of limited partnership is required to be signed and filed with the secretary of state's office, and in some instances, a limited partnership agreement is also required to be filed.
A certificate of limited partnership contains information about the limited partnership such as its name, address, purpose, who the general partners are, and their business address. The requirements of each state vary.
A limited partnership needs to obtain a registered agent for receiving service of process, as well as obtain an EIN. It also needs to obtain any necessary licenses and permits and the local, state, and federal levels.
Limited partnership agreement
A limited partnership agreement contains the same basic information as a general partnership agreement but addresses some additional provisions pertaining to limited partners. A limited partnership agreement should address:
- Contributions. Specify the amount and time of contributions to be made by each partner.
- Management and control. Identify whether some or all the general partners will manage and control the partnership.
- Profit and loss sharing. Specify how the profits and losses will be allocated to the partners.
- Distributions. Indicate when distributions of cash or property will be made.
- Partner's responsibilities and duties. Describe the responsibilities of each general partner.
- Withdrawal. Identify how a partner's interest will be valued if the partner withdraws from the partnership.
- Death. Identify how a partner's interest will be valued if the partner dies.
Additional topics to be included in a partnership agreement if applicable:
- Admission of partners. Indicate the process for admitting new general and limited partners into the partnership.
- Right of first refusal. Specify that the partnership or individual partners will have the right to purchase a withdrawing partner's interest before the partner can offer to sell the interest to someone outside the partnership.
- Duration of the partnership. Indicate the life of the partnership along with any events that may cause the partnership to dissolve prematurely.
- Continuation of the partnership. Identify the criteria to enable the partners to continue the partnership if an event causing the dissolution of the partnership occurs.
