Going into business with partners can be exciting and scary at the same time. If the partnership goes sour, picking up the pieces can severely tax your company’s resources and financial health — as well as take an emotional toll on all parties involved. That’s why it’s a good idea to study the pros and cons of structuring your business as a partnership before you make a decision.
There are two types of partnerships: general partnerships and limited partnerships. General partnerships are made up of two or more partners where all the partners manage and are responsible for the business’s debts and operations. Each partner contributes skills, money, and time, and each shares in the company’s profits and losses.
A limited partnership may have both general partners and limited partners. The limited partners in the relationship are investors and are not liable for the same responsibilities as the general partners.
Let’s take a look at the advantages of a general partnership:
- Simplified taxes: The biggest advantage of a general partnership is the tax benefit. Businesses structured as partnerships do not pay income tax. Instead, all profits and losses are passed through to the individual partners. The partnership still files a tax return stating the business’s profits and losses, but it does not pay taxes on the income. The partners must also file tax returns that show their individual shares of the company’s profits and losses — although partners are not treated as employees. For more information on tax-related issues of partnerships, see the IRS Partnerships website.
- Less paperwork: Creating a general partnership is simpler, cheaper, and requires less paperwork than forming a corporation. However, the partnership should file a partnership agreement in the county where it does business. Partnership agreements should state the purpose of the business and the responsibilities of each partner. Consult an attorney if you’re unsure of how to create a partnership agreement.
Here are the disadvantages of forming a general partnership:
- Legal liability: If you’re not structuring your business as a corporation, realize that a general partnership brings with it personal liability for all the business’s obligations and debts. If the company gets sued or hauled into bankruptcy court, all fines are the responsibility of the individual partners. Also, most partnerships allow any partner or owner in the company to make decisions on behalf of the company in general. Even if a partner is acting on their own, all partners are responsible for the outcome of those decisions.
- Management issues: Because partners can make investments from their personal finances and the money invested is then owned by all partners, it’s easy for questions of reimbursement to arise. What if one partner didn’t want the company to take that money and doesn’t want the company to pay it back? The same kinds of issues can arise with purchases for the company or even with decisions on which suppliers or clients to take on. Having all partners equal in power and responsibility can cause problems unless proper guidelines are set out.
Partnerships are often formed among friends and colleagues, which can make matters even more delicate. To avoid problems down the road, it’s best to consult an attorney at the outset and ensure your partnership gets off to a good start.