What is a Partnership?

The advantages of a partnership come from it being an agreement between two or more people to both finance and, in some cases, operate a business. These benefits are several-fold. Partnerships are legal entities that remain separate from the individuals themselves. Generally speaking, however, the profits and losses from the business are listed on the partners’ tax returns.

In a general partnership, each partner bears equal authority and responsibility to run the business. In other words, each partner is involved in day-to-day operations of the business. Similarly, each partner makes management decisions. The actions of one partner often bind the entire partnership. For example, if one partner signs a contract on behalf of the business, all the partners become responsible for the contract.

Establishing a partnership is not hard. Establishing a partnership agreement, however, requires a significant amount of time and attention to detail. A partnership agreement should include the following essential elements in detail:

  • The financing of the business
  • The responsibilities of each party
  • A detailed account of how the death of one partner impacts the partnership
  • A detailed plan regarding steps required when one or both parties wish to dissolve the partnership

Due to complexities and potential unanticipated circumstances, it is a good idea for a qualified attorney to write the partnership agreement.

General Advantages to Business Partnerships

There are many advantages to business partnerships. Partnerships benefit from the combination of two skill sets. They are easy to establish. Partnerships provide additional avenues for raising funds as well as increasing borrowing capacity. Partnerships allow each partner to focus on their individual strengths. When challenges present themselves, partners have the luxury of brainstorming as a team.

Partnerships, unlike corporations, can operate in multiple states without obtaining a new permit in each state. Additionally, general partnerships are subject to less government oversight and fewer regulations than corporations. Finally, partnerships provide moral support.

General Disadvantages to Business Partnerships

Disadvantages include the aforementioned liability for the actions of the other partners. Profits must be shared with partners, regardless of how hard each partner may have worked for the profits. Decisions are shared, which can lead to disagreements that must be resolved. Partnerships are a long-term commitment. Breakups can be messy and traumatic.  Finally, for good or for ill, in many states, a partnership is not required to be reduced to writing. While a written agreement makes proof of the partnership easier, a written agreement is not required. In Texas, for example, an oral agreement to form a partnership will suffice.

Types of Partnerships

There are two different types of partnership, general partnerships and limited partnerships. In a general partnership, there are three essential elements:

  • Profits and losses are shared
  • The business is jointly owned
  • There is an equal right to management of the business

In a limited partnership, on the other hand, there is one general partner, and one or more limited partners in the business. The general partner bears the responsibility of managing the business. Limited partners, on the other hand, contribute assets to the business, but do not contribute to managing the country.

Advantages of a General Partnership

Partnerships do not pay taxes as a business. Rather, each partner files their profits and losses from the business on their own personal income tax return. Partnerships are relatively easy to establish. Unlike a sole proprietorship, in a partnership, there is generally an increase in available funds for the business. Additional partners bring a wider base of knowledge, contacts, and skills.

Disadvantages of General Partnerships

All partners are responsible for the actions and choices of the other partners. This includes liability for contracts and torts, as well as breaches of trust. Additionally, each partner is liable for all of the debts and obligations of the business. When the business does not have enough money to pay debts, creditors may take the personal assets from any or all of the partners to meet the obligation.

Unless otherwise written into the partnership agreement, one partner cannot transfer their interest in the business without the consent of all of the other partners. Finally, partnerships can be unstable, as there is a danger of dissolution if one partner wishes to withdraw from the business, dies, or becomes incapacitated.

Advantages of a Limited Partnership

In a limited partnership, there are limitations on liability. Limited partners are liable only for the amount of money invested in the business. A business creditor cannot seek a limited partner’s personal assets, unlike in a general partnership. Limited partnerships are attractive to investors due to this limited liability. Like general partnerships, profits and losses pass through the business to the partners. They are taxed personally.

Disadvantages of a Limited Partnership

In a limited partnership, where a limited partner becomes active in the business, they may assume general partner liability. Once this occurs, the partner becomes personally liable for the debts of the business. States require a certificate of limited partnership filed with the state. This filing comes with filing fees.

C Corporations

A corporation is a separate legal and tax entity created by shareholders who provide property, financing, or both, for the stock for the corporation. The corporation is separate from those who manage the corporation and operate the business.

Advantages of a C Corporation

With a C Corporation (sometimes referred to as a “C Corp”), many investors pool their money, which makes the business easier to start and run. Shareholders are not personally liable for the debts of the corporation. When a corporation fails, the shareholders may lose the financial investment they made, but they are not responsible personally for the debts of the corporation.

Disadvantages of a C Corporation

C Corps require the filing of Articles of Incorporation with the Secretary of State. This, of course, comes with a filing fee. The profits of a C Corp are taxed when earned. Additionally, the profits distributed to the shareholders as dividends are also taxed. This system is referred to as double taxation.

Shareholders with voting stock receive votes based on how many shares they own. Consequently, shareholders with a significant amount, or the majority of the corporation’s voting stock have a stronger voice in managing the business. Smaller shareholders will not have as significant of a voice.

S Corporations

S Corporations (also referred to as an “S Corp”) enjoy the advantages of limited liability but do not have the same income taxes as a C Corp.

Advantages of an S Corp

Income is only taxed at the shareholder level in an S Corp. It is not taxed at the corporate level, unlike a C Corp. Shareholders are not personally liable for the debts of an S Corp. If an S Corp fails, the shareholders may lose some of all of their investment in the corporation. However, they are not liable for the corporation’s debts.

Disadvantages of an S Corp

Like a C Corp, an S Corp must have Articles of Incorporation filed with the Secretary of State. This comes with a filing fee. Also, like C Corps, a shareholder with a significant or majority amount of voting stock has more say in management decisions than shareholders with less voting stock.

Limited Liability Corporations

Limited Liability Corporations, also know as an LLC, are a hybrid between a partnership and a corporation. The LLC offers the limited liability of a corporation, but comes with the tax advantages found in a partnership.

Advantages of an LLC

In an LLC, profits pass through the business and the taxes are paid by the owners of the company. Member liability is limited to the amount of each member’s investment. Each member is permitted to fully participate in managing the company. Both corporations and partnerships can be LLC’s. There are no limits on the number of members participating in a given LLC. Unlike general and limited partnerships, an LLC can be comprised of just one member. An LLC offers a significant amount of flexibility. The members of the LLC determine how to approach various business aspects through the operating agreement.

Disadvantages of an LLC

LLC’s come with increased complexity in their formation. LLC’s may be classified as partnerships, corporations, or a sole proprietorship for tax purposes.

Sole Proprietorships

A few words about sole proprietorships is in order. A sole proprietor may be one of the easiest ways to start a business. In a sole proprietorship, the owner is considered the business.

Advantages of a Sole Proprietorship

The owner receives all the profits in a sole proprietorship. Sole proprietorships are easy to set up and cost little money. There is no filing fee because no filing is required. Owners are free to make their own decisions regarding the business in the present and in the future. The owner only pays personal income taxes on the profits earned.

Disadvantages of a Sole Proprietorship

As with other business structures, there are disadvantages to sole proprietorships. For example, the owner is solely responsible for all liabilities incurred by the business. When the business does not have enough assets to pay debts, the personal property and assets of the owner can be in jeopardy. While a partnership provides two or more people and their attendant sources of potential capital, in a sole proprietorship, the owner can rely on themselves alone. Upon the death or incapacitation of the owner, the business may end altogether.

Determining What Is Right for You

Its normal to feel confused or even overwhelmed when faced with deciding what type of business is right for you. The first question may be to ask, “What are your goals as an entrepreneur?” Each type of business has both pros and cons. Both should be carefully weighted before making a decision about the type of business will best meet your needs.

A partnership may be the best choice for those just starting out, or those who plan to run businesses with 20 employees or less. Partnerships are easy to form (although business owners are cautioned about the need to carefully construct the partnership agreement to address possible challenges). Answering to just one or two other partners, as opposed to hundreds of shareholders, for example, can make decision making easier. Partnerships allow for quick decision making by the few people at the top.

If You are Considering a Business Partnership

If you need help establishing the documents for a partnership or corporation, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Stripe, and Twillo.