Key Takeaways

  • A partnership is a collaborative business arrangement between two or more individuals sharing profits, losses, and decision-making.
  • The operation of each partnership depends on its type: general, limited, limited liability, or joint venture.
  • Key components of partnership operations include contributions, profit sharing, liability, management structure, and dissolution procedures.
  • Well-drafted partnership agreements are essential for defining responsibilities and minimizing disputes.
  • Understanding how each type of partnership works helps ensure legal compliance and smooth business functioning.

How does a partnership work is a common question amongst business owners wanting to create a formal business partnership. When two or more individuals form a partnership, they often bring together their knowledge, background, financial resources, and connections to help their business succeed. Sometimes, however, partners have different short and long-term goals and objectives. While a partnership can be a great business structure for many, it might not be the best type of business for everyone.

Business Partnership Defined

A business partnership involves two or more people coming together to form a business of some kind. The partners will generally pool their money together in an effort to raise capital for the company’s initial operations. The partnership business structure, unlike the corporate structure, is not a separate entity from the individual owners. Therefore, the partnership will not provide limited liability protection as the corporation and LLC provide.

Furthermore, unlike the LLC or corporation, there is much less paperwork when forming a partnership. In essence, the partnership works similarly to that of the sole proprietorship, as the owners in both types of business structures don’t benefit from limited liability protection and these entities both operate as pass-through tax entities wherein the owners will report the businesses profits on their personal tax returns.

Types of Partnerships and Their Operations

Understanding how the operation of each partnership works requires a breakdown of the different partnership structures:

1. General Partnership (GP):In a GP, all partners equally manage the business and share in profits, losses, and liability. Each partner is personally liable for the debts of the business, and any partner can bind the business to contracts.

2. Limited Partnership (LP):This structure consists of one or more general partners and one or more limited partners. General partners manage the business and have personal liability, while limited partners contribute capital and share profits but have limited liability and no role in day-to-day management.

3. Limited Liability Partnership (LLP):An LLP protects each partner from personal liability for other partners' actions. LLPs are often used by professional groups (e.g., lawyers, accountants) and allow all partners to have limited liability while still participating in management.

4. Limited Liability Limited Partnership (LLLP):An emerging hybrid of LP and LLP, the LLLP provides limited liability to both general and limited partners, though its recognition varies by state.

Each partnership type affects how daily operations, profit distribution, and liability are handled—making it essential to align the structure with business goals.

Advantages of a Partnership

There are many advantages to operating a partnership, including the following:

  • The partnership is simple and cheap to form
  • Tax requirements for a partnership are less formal and simple to fill out
  • The partnership business structure can attract potential employees who might want to become a partner in the future

Once you and your business partner have created an idea for a company, you’ll want to spend a great deal of time working with one another to plan how you will oversee the business. Before setting up the business, first identify your short and long-term goals. What do you see for your business? Do you want to hire employees? Do you ultimately have a long-term goal of converting to a corporation and offering stock to the public? Do you want to bring on new partners if your company succeeds?

These are all important items to discuss with your potential new business partner, as you want to avoid any potential pitfalls and arguments down the line before you and your business get started. Such disagreements could ultimately lead to dissolution of the business.

Particularly, forming a partnership is cheap and straightforward. There are no formal steps to forming your partnership, as there is with a corporation. Additionally, there are no significant fees associated with forming a partnership. Since the general partnership operates as a pass-through tax entity, similar to that of an LLC, your partnership doesn’t pay corporate income taxes. Instead, the partners will report the profits and losses from the partnership on their personal income tax returns. While the partnership isn’t required to pay corporate income taxes, the business must still submit an informational return that provides the IRS with the company’s profits, expenses, and losses, while also identifying the share of partnership income that will be reported on the partners’ personal income tax returns.

The partnership business structure can be attractive to potential employees. Such employees might have an ability to also become a partner should the company be doing well at any given point in the future.

Key Elements in the Operation of a Partnership

To fully understand how the operation of each partnership works, consider the following essential components that govern a partnership’s functioning:

1. Partner Contributions:Each partner typically contributes cash, property, skills, or services. These contributions determine ownership percentages, profit-sharing ratios, and influence.

2. Profit and Loss Allocation:Profits and losses are usually shared in proportion to contributions unless specified otherwise in the partnership agreement. Partners report their share on personal tax returns.

3. Management Roles:In general partnerships, all partners have equal rights in managing the business unless otherwise agreed. In LPs and LLPs, management is typically limited to general partners.

4. Decision-Making and Voting:Most decisions require majority consent unless it involves significant actions (e.g., taking on new partners, dissolving the business), which may require unanimous agreement.

5. Taxation:Partnerships are pass-through entities for tax purposes. While the partnership files an informational return (IRS Form 1065), individual partners pay taxes on their share of income.

6. Fiduciary Duties:Partners owe duties of loyalty and care to the partnership. They must act in the best interest of the business and disclose conflicts of interest.

7. Exit and Dissolution:The departure of a partner can trigger dissolution unless otherwise stated. A well-drafted partnership agreement outlines procedures for withdrawal, buyouts, or succession.

Joint Venture

A joint venture is an agreement between two or more businesses that agree to share resources, expenses, employees, and other items to accomplish a shared goal. The joint venture might not have a purpose of making a profit, as it can be entered into solely in an attempt to offset the costs and risks as opposed to having one company take on all of the risk.

Generally, the joint venture will be limited in scope and time. Therefore, after the period of time has ended, so too has the joint venture agreement. Similarly, if the goal has been achieved, then the joint venture agreement will end. There are a few ways to establish a joint venture, including setting up a brand new business entity that will handle all of the joint venture efforts and tasks. It can be a corporation, LLC, or partnership. However, you need not establish a formal business structure for a joint venture. It can be a simple written agreement between the two businesses.

Drafting an Effective Partnership Agreement

A strong partnership agreement is key to preventing disputes and ensuring smooth operations. This document should clearly outline how the operation of each partnership works by addressing:

  • Capital contributions and ownership percentages
  • Profit and loss distribution methods
  • Duties and decision-making authority of each partner
  • Dispute resolution mechanisms
  • Admission of new partners
  • Exit strategies and dissolution terms

Without a written agreement, partnerships default to state laws, which may not reflect the partners’ intentions. For tailored protection, it's wise to consult a legal professional. You can find a qualified business attorney on UpCounsel to assist with partnership agreements.

Real-World Examples of Partnership Operations

To illustrate how the operation of each partnership works, consider the following scenarios:

  • Law Firm (LLP): Each partner shares in revenue but is shielded from malpractice claims made against other partners.
  • Real Estate Investment (LP): Limited partners fund a development project while a general partner oversees construction and leasing.
  • Retail Business (GP): Two friends co-own and co-manage a boutique, splitting profits equally.
  • Tech Startup (Joint Venture): Two companies pool resources to develop a mobile app for a shared client base.

These examples highlight how operational responsibilities and liabilities shift based on the partnership type and terms of the agreement.

Frequently Asked Questions

  1. How does the operation of each partnership work in different industries?
    It varies widely. Professional firms often use LLPs for liability protection, while real estate groups favor LPs to attract passive investors. Operational control depends on industry standards and legal structure.
  2. What happens if a partner wants to leave the business?
    Unless addressed in the partnership agreement, a partner’s departure can dissolve the business. Agreements typically include buyout clauses or succession plans.
  3. Are all partners equally liable in every type of partnership?
    No. In GPs, all partners have unlimited liability. In LPs and LLPs, liability is limited for certain or all partners depending on their role.
  4. Do partnerships require a written agreement?
    While not legally required, written agreements are highly recommended to clarify roles, reduce disputes, and protect the business.
  5. Can a partnership evolve into another business structure?
    Yes, partnerships can be converted into LLCs or corporations to access limited liability, raise capital, or prepare for growth.

If you need help learning more about partnerships, 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, Menlo Ventures, and Airbnb.