A partnership is created when two or more individuals decide to become co-owners of a business to make a profit. Partnerships can be formed by verbal agreement between the parties, making it one of the easiest forms of businesses.
Partnerships have several advantages over other types of businesses ranging from flexibility to the simple organizational structure. However, depending on the type of partnership business you intend to establish, partnerships can also be a risky affair.
It’s important to understand the legal implications of a partnership, the risks involved, and how to protect yourself and your possessions against the liabilities of the business.
How to Form a Partnership
A partnership can be formed in any way convenient for the partners. You can form a partnership with a handshake, oral agreement, or a written partnership agreement. However, starting a relationship that involves money and sometimes personal assets without spelling out the details is risky and can lead to bitter disagreements which can cause the dissolution of the partnership.
To avoid such problems in the future, it’s essential to have a written partnership agreement with legally binding provisions on the duties and responsibilities of each partner. While you can find several partnership agreement templates on the internet, you will be making a big mistake if you use them.
It’s better to hire a local attorney who is conversant with the local corporate laws and their implication on partnerships. An experienced attorney can help you draft a legally binding document that will spell out who does what, how profits will be shared, liabilities, and every other important aspect of the business.
Forms of Partnerships
There are various forms of partnerships, ranging from the simple general partnership, the limited partnership to the limited liability partnerships.
A general partnership is the default legal status of every partnership. Of all partnerships, the general partnership is the simplest with regards to its management structure, legal status, and tax status. A general partnership can be formed through an oral agreement.
All the partners in a general partnership share the management duties and profits based on their percentage ownership. However, a general partnership doesn’t protect its owners from its liability. While the partners can do as they please with the finances and management of the business, they are also personally liable to the business. The implication is that the personal assets of each partner can be used to settle the debts and liabilities of the partnership.
General partnerships and other types of partnerships do not pay taxes. The profits, losses, and liabilities of the enterprise are passed through to the partners. As such, partners pay the business tax through their personal income tax.
The structures of a limited partnership are more complex than that of a general partnership. In a limited partnership, there are two classes of partners including the general partners and the limited partners.
The general partners are responsible for managing the business and are personally liable for its debts. On the other hand, the limited partners have no management responsibilities, and their liabilities to the business are limited to their financial contribution.
Unlike general partnerships, a limited partnership must be registered with the state where it hopes to operate.
Limited Liability Partnership
A limited liability partnership is usually formed by professionals who are licensed to provide specialized services such as doctors, accountants, attorneys, and architects. A limited liability partnership protects each from the misconducts of other partners, but each partner is personally responsible for their actions regarding the business.
An example is a limited liability partnership formed by a team of doctors. Each doctor is protected from any lawsuits that arise from the professional misconducts of others but still personally liable for his own actions.
It’s for this reason that states require partners or members of professional associations to buy professional liability insurance to protect them against claims leveled against their person in the course of discharging their professional services.
Management of Partnerships
In general partnerships, all the partners share management responsibilities, like they share personal liabilities and profits of the business.
However, the partner with the majority stake in the enterprise has an advantage over the minority interests. The partners also manage other forms of partnership businesses based on their ownership interest.
Partners can enter into agreements on behalf of the partnership, except where the partnership agreement states otherwise. When important decisions concerning the business are to be made, or disputes arise, partners can take a vote. However, the partners with majority interest will always carry the day.
Partnerships are subject to state laws. However, partners can decide to override the provisions of state laws.
A partnership agreement is a written document that spells out the ownership interests and duties of partners who formed the business. The document is legally binding according to the laws of the state where the partnership is operating and serves as a code of conduct for the partners.
A partnership agreement should be prepared immediately the partners have decided to form the enterprise, preferably by an experienced attorney. The partnership agreement covers some the following:
- The purpose of the partnership
- Sharing formula for ownership interest- Spell out each partner’s share of ownership
- Profit/salary distribution- How to withdraw money from the business
- Voting Rights
- Withdrawals/Entry of Partners-State how partners will leave or become partners in the enterprise
- Death/Disability-How to manage the shares and capital of a dead or disabled partner
- Dissolution- How to dissolve the partnership if differences become irreconcilable
Tax Status of Partnerships
Partnerships don’t pay business income tax. Rather, the profits and losses of the company are passed to the partners who pay it through their personal income tax filings. This is one of the advantages of partnership compared to LLCs and corporations.
Personal liability means your assets can be used to pay off the debts and liabilities of the partnership if the business assets can’t cover its obligations. In that case, creditors can go after your bank accounts, shares, automobiles, and property to offset the balance of the debt owed by your partnership.
Should You Start a Partnership?
Partnerships are easy to form. The business does not require elaborate registrations and enjoy low taxes. However, partners are subject to the liabilities of the enterprise. If you wish to form a partnership business, it’s important to hire an experienced attorney to draft a sound partnership agreement to protect your interests and assets before committing resources to the business.