General partnerships have many benefits, but perhaps the most compelling is the ease with which they can be set up and maintained. You do not have to register with your state and pay fees, as you do to establish a corporation or limited liability company (LLC). And because a general partnership is normally a “pass through” tax entity — meaning the partners, and not the partnership, are taxed — filing income tax returns is relatively easy. Unlike a regular corporation, there is no need to file separate tax returns for the corporate entity and its owners.
Another advantage of general partnerships is the flexibility they offer. In partnership agreements, the partners are free to set their responsibilities and benefits as they see fit or as the needs of the business dictate. The structure of the organization and the distribution of profits and losses are much more flexible in a general partnership than they are in a corporation. Because of this, an individual partner can be rewarded with higher profits for taking on more financial risk. Typically, corporations distribute dividends evenly according to the percentages of stock held by each stockholder.
Partnerships are also considered a discrete asset and as such (as opposed to a sole proprietorship) can be transferred to other people, heirs, or estates. Transference is usually limited by the terms of the partnership agreement.
But partnerships can also be risky. The business-related acts of one partner can legally bind all other partners. So it’s essential that you enter into partnerships only with people you trust. It is equally essential that, no matter how much you trust your partners, you execute a written partnership agreement establishing each partner’s share of profits or losses, day-to-day duties, and what happens if one partner dies or retires.
Another disadvantage of doing business as a general partnership is that all partners are potentially personally liable for all business debts and lawsuits. At a minimum, each partner is financially responsible for his or her share of the business debt. But in many cases, it is the partner with the greatest assets who loses the most if the business fails. Of course, a good insurance policy can help reduce lawsuit worries, and many small, savvy businesses don’t have debt problems.
General partnerships are also limited in their ability to raise money. Other than debt financing, partnerships are often unable to get large chunks of cash. Although a partnerships can raise capital by selling equity interests, that’s very difficult to do on a large scale because of potential personal liability and the limited resale market for partnership equity.
Bottom line: Avoid general partnerships and consider forming an LLC or an S corporation for start-up businesses.