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How - and Why - Should We Form A Partnership?

When more than one person starts a business, that business is a partnership. There are two types of partnerships – a general partnership and a limited partnership. While partnerships are run much like sole proprietorships, there are many differences, advantages, and disadvantages. It is important to establish guidelines for the partnership right from the start, so that each partner knows what their role in the company is, and what their liability is as well.

A general partnership is the easiest type of partnership to set up. It is set up almost exactly like a sole proprietorship in that the only requirement is a business license, but in most cases, a partnership agreement also exists – even though it is not required. The partnership agreement should be in writing, signed by all partners, and notarized by a notary public. Many partners hire separate attorneys to draw up the agreement, and to ensure that the agreement is suitable for each partner.

The partnership agreement should establish how profits and losses will be shared, how the partnership will be terminated if one of the partners wants out or dies, and other important guidelines concerning how the business will be run. Each state, with the exception of Louisiana, has laws that govern partnerships. This is called the Uniform Partnership Act. If a partnership agreement does not exist, then the UPA rules in regards to partnerships. However, the UPA is not designed to protect partners from different types of situations, and should not be depended on to govern a partnership.

The partnership agreement should contain the name of the partnership, state how profits, losses, and draws will be allocated, state what authority each partner has in the business, and state what responsibility each partner has. Furthermore, there should be a clause that states how disputes will be resolved, and how the partnership will be dissolved. There should also be a clause stating the guidelines for admitting new partners into the partnership. It is important to get as much information into the agreement as possible.

Limited partnerships are another matter. They are more difficult to set up than a general partnership, and the costs of setting up are generally much higher. Limited partnerships are not usually a good answer for most small businesses. In effect, the business is run by one partner, which is considered to be a general partner. The limited partners have limited dealings in the day to day operations of the business, limited authority, and limited liability. Basically the limited partner exchanges control for protection from liability. The general partner exchanges protection from liability for more control in the operations of the business.

For many small businesses, a partnership – whether it is general or limited – isn’t a good choice for business structure. Even though it is cheaper and easier to set up a partnership, incorporating, or forming a limited liability company should strongly be considered. In some cases, a corporation may not be suitable either – but a limited liability company almost always is because it offers the protection of a corporation, but is operated as a general partnership and all partners are protected.