Types of Business Partnerships: Everything You Need To Know
There are 4 types of business partnerships: partnership, general partnership, limited, partnership & limited liability partnership. Learn more about them here.7 min read
Finding information about types of business partnerships, the people typically involved in them, steps to forming a partnership, along with the advantages & disadvantages of various partnerships can be challenging. Partnerships are a common occurrence in the business world, but is one right for you and your business?
A partnership is a single business where two or more people share ownership. In a partnership each person contributes to all aspects of the business, sharing the profits and losses of the business as well. The structure of how many people make up the partnership and their individual responsibilities breaks down into three subcategories.
The type of partnership that you choose for your business will impact several important issues, including the personal liability of each partner, how profits will be distributed, and management responsibilities. Learning about the types of business partnerships will help you to choose the option that best meets the needs of your business.
A General Partnership
An association of two or more persons that carry on as the co-owners of a business in order to generate a profit. The default rule is equality between all members and the only way to change this is through a formal written agreement. Each partner possesses an equal voice in management and the authority to act as agent for the partnership. Each partner can be held liable for all debts of the partnership, and for torts committed by other partners within the course of the partnership's business.
A Limited Partnership
A limited partnership is formed by two or more persons, having one or more general partners and one or more limited partners. A limited partner has no voice in the active management of the limited partnership, which is conducted by the general partner(s). Every limited partner's liability is limited to the capital he has contributed to the partnership.
Choosing this type of business partnership will not be beneficial for every partner involved in the business. The general partner, for example, will not receive the same limited liability protections as the limited partners. General partners can be held liable for all the debts of the business. As such, personal assets may be at risk if the partnership is ever involved in a lawsuit.
Whether you are a general partner or limited partner, you will benefit from the profits of your business. Limited partnerships are quite beneficial for individuals that wish to invest in a business but do not want to hold personal liability for the obligations of said business. A limited partner is often referred to as a silent partner because they don't actually have any input in the management of the business. A limited partners only responsibility is investing money in the partnership.
Limited Liability Partnership
Limited liability partnerships (LLP) have much more in common with limited liability companies (LLC) than they do other types of business partnerships. With an LLP, partners will receive the same beneficial taxation provided by a general partnership, and will also be shielded from the debts, and liabilities of the business. In addition, every partner in an LLP will be protected from the actions of other partners.
The best way to understand an LLP is as a combination of a partnership and a corporation. Forming an LLP means you'll enjoy the same liability protections afforded to corporations and will also have the flexible operations that are the main benefit of a partnership. While a partner in an LLP can still be held liable for their own negligent actions, they will not be liable for the actions of anyone else in the business.
It is possible that an LLP will be subject to tax rules that would not normally apply to a partnership. The reason for this is that LLPs have certain characteristics that are not commonly found with other partnerships. Unlike local tax authorities, the IRS does view LLPs as standard partnership. This means these entities can take advantage of pass-through taxation rules, meaning business profits are taxed on partner's personal returns instead of the business being taxed directly.
If you're interested in forming a limited liability partnership and already have an existing partnership in place, you will not need to make any alterations to your partnership agreement. You can, however, modify your partnership agreement if you so desire. The only thing you need to do to establish your LLP is to file an application with your state. When registering your partnership, you will need the name of your partnership and your principal business location. Some states may require additional information:
- How many partners your business possesses.
- A business description.
- A statement indicating your partnership has insurance.
- A statement acknowledging your partnership's liability status may one day expire.
Personal injury law firms commonly make use of this type of business partnership. Other businesses that can benefit from forming a limited liability partnership include:
- Accounting firms
- Architectural business
- Healthcare practices
Each partner has equal management rights and is an agent for the business. Only the LLP is liable for business obligations. All partners are liable for their own tortious conduct and for those they supervise.
Forming a Partnership
To form a general partnership at common law, nothing more than an agreement between two people is needed. Typically, most people put this into a written agreement for legal and operational purposes. To form any other partnership you must file paperwork to register your business with the state, generally done through the Secretary of State's office.
Additionally, you will need to establish and register a business name along with complying with all state regulations. Taxation issues become increasingly complicated as more people are added to a business, making it essential to do legal research on the financials of a partnership to comply with federal/state law.
Advantages of a Partnership
- Liability issues within a partnership are much better than a sole proprietor, as you can allocate limited partners with significantly less liability.
- A partnership disperses the burdens of a business among several people, which typically will also increase the chance of success when resources are pooled together.
- It is easy to change your legal structure later in the life of a company, and is very easy to form in the beginning.
- Receiving credit will be easier with two people, rather than just having one person, which means more capital is available for your business.
Disadvantages of a Partnership
- The pros of having more people in a business can also complicate decision-making and decrease profits.
- Liability may be less for limited partners, however, general partners retain full liability among the owners for their own actions, as well as all other general partners.
- Disagreement between equal sharing partners is one of the biggest reasons company's dissolve.
- A partner who chooses to leave will be costly, as you will have to value their assets and replace that essential person who has taken on a lot of liability/responsibility.
Should You Form an LLC or a Partnership?
One of the most important factors to consider is whether or not forming a partnership will be more beneficial than establishing a limited liability company (LLC). Recently, LLCs have overtaken general and limited partnerships as the most popular business structure. The main reason for this is that LLCs offer much stronger liability protections than partnerships and are also much easier to run.
For example, in a limited partnership, at least one partner must remain a general partner and this partner will be exposed to liability. No such requirement exists for an LLC. With an LLC, none of the company members need to take place in the day-to-day operations of the business. Instead, members of the LLC can hire an outside manager to run the company.
Partnerships, no matter which type you choose, are much easier and more affordable to establish than limited liability companies. So, if you are interested in investing in a business and want to limit your liability, but don't want to expend the effort needed to form an LLC, a partnership can be an excellent choice.
What to Consider When Structuring Your Business
When you're starting a new business, several important factors must be considered. This includes how your company will be structured. Choosing the correct structure for your business is an important decision and requires weighing several issues, including your startup needs and your business's future growth potential.
Flexibility is an important issue to think about when structuring your business. Where do you see your company in a few years and will the structure you have chosen allow your business to expand in the way that you desire? You should study your business plan and use the information that it contains to structure your business. The structure you choose should support future growth, not hinder your company from expanding.
You should also consider the complexity of any business structure you are choosing. Sole proprietorships and general partnerships are very simple business structures that can be easily formed. Unlike corporations and limited liability companies, they are not subject to many rules and regulations. If you're running a small business, selecting a simple business structure is almost always the best choice.
Personal liability should also be taken into account when structuring your business. With some types of business structures, you'll be completely liable for the debts of your business, and with others you'll receive liability protections that will shield your personal assets from lawsuits filed against your company. Corporations, limited liability companies, limited liability partnerships, and limited partnership all offer liability protections, whereas general partnerships and sole proprietorships provide no protections.
Finally, you need to think about how your business will be taxed. Some business structures offer beneficial pass-through taxation, such as limited liability partnerships, and other structures will subject you to double taxation. Your goal should be to choose a structure that will keep your taxes as low as possible, both at the state and federal level.
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