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Starting a Partnership

Filed under Form of Business. Fact checked on May 24, 2012.

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There are basically two types of partnerships--general partnerships and limited partnerships. General partnerships are a risky way to operate the business because of personal liability concerns. A limited partner can avoid the personal liability, but loses the ability to participate in day-to-day decision-making

You have two choices when forming a partnership—general partnerships and limited partnerships:

  • General partnerships: A general partnership consists of general partners who share the management of the entity and are personally responsible for the partnership's obligations.
  • Limited partnerships: A limited partnership consists of two classes of partners—general partners and limited partners. The general partners manage the limited partnership and are personally responsible for its obligations. The limited partners are similar to shareholders of a corporation. They cannot participate in the management of the entity, but can  determine who will manage the partnership. The limited partners share in the profits of the partnership, but their losses are limited to the amount of their capital contribution.

Forming a General Partnership

If a business is going to be owned by more than one owner, the simplest business form to create and operate is a general partnership. Although a partnership is more complicated to form than a sole proprietorship, it is not as complicated as a corporation.

Forming a partnership entails an agreement between two or more prospective partners. The agreement can be oral, but should be written and signed by all partners to avoid later conflicts. Virtually anyone can be a partner. A partner can be an individual, a partnership, a limited liability company, a corporation, or a trust.

The flexibility of a partnership allows the business to operate in a manner that best suits the business needs at the time the business starts and later when the business has matured. For example, when the business is just beginning, one partner may have skills that are valuable to the business, but little capital. Another partner may have capital, but not the requisite skills. The partner with skills can contribute services to the partnership while the other partner contributes capital.

Later, when the business has grown, new partners can be admitted, yet their management capacity can be limited to prevent the new partners from usurping the original partners. When a partner contributes capital to a partnership, the partner receives an ownership percentage in all assets of the partnership, not just in the property contributed.

General partnership liability. All partners are jointly and severally liable for the obligations of the partnership. Joint and severe liability means that each individual partner can be held responsible for all obligations of the partnership. A partner who pays an entire obligation can collect the other partners' pro rata share of the debt. Of course, the other partners may not be in a position to repay the partner.

Work Smart

Any partner can enter into a contract on behalf of the partnership. By doing so, a partner can bind all partners in an unfavorable contract, since all partners are jointly and severally liable for the obligations of the partnership.

General partnership protective measures. A partnership of two or more individuals may require the efforts of all the partners to succeed, especially in the early life of the business. If one of the partners withdraws or dies, the existence of the partnership may be threatened. To protect the partnership and the remaining partners, consider buy/sell agreements and key person life insurance policies on the partners.

A buy/sell agreement specifies how the value of a partner's interest will be determined if a partner wants to leave the partnership. Having a buy/sell agreement in place minimizes disputes over value and smoothes out the purchase of the withdrawing partner's interest by the partnership or other partners.

Key person life insurance is a life insurance policy on the lives of key members of an organization to provide cash in the event of the death of a key member. The beneficiaries of a key person policy are the organization or the organization members. In a partnership, key person life insurance can be purchased for all partners or on some designated class of partners such as senior partners. The life insurance proceeds can be used by the partnership to keep the business going in the absence of the key partner. The proceeds can also be used to buy out the deceased partner's interest pursuant to a buy/sell agreement.

General partnership forms needed. A partnership should obtain a Federal Employer Identification Number by filing Form SS-4, Application for Employer Identification Number.

Tools to Use

Among the Business Tools is Form SS-4. It is in Adobe Portable Document Format (.pdf), and you will need the free Acrobat Reader to view and print the file.

A partnership may also have to file a business certificate with the jurisdiction in which it is going to do business. If the business will operate under a name that is different from the owner's name, most jurisdictions will require that a fictitious owner affidavit be filed. A fictitious owner affidavit informs the jurisdiction that the business is operating under an assumed name and indicates the business owner's name.

To find out what the requirements are in your jurisdiction, call the county clerk's office, which will be located at the courthouse in the county seat.

General partnership agreement contents. The partnership agreement is a complicated document that should be drafted by an attorney. At a minimum, address the following subjects in the partnership agreement:

  • Contributions: The amount and time of contributions to be made by each partner should be specified.
  • Management and control: Identify whether some or all partners will manage and control the partnership.
  • Profit and loss: Specify how the profits and losses will be allocated to the partners.
  • Distributions: Indicate when distributions of cash or property will be made.
  • Partner's responsibilities and duties: Describe each partner's responsibilities and duties.
  • Withdrawal: Identify how a partner's interest will be valued if the partner withdraws from the partnership.
  • Death: Identify how a partner's interest will be valued if the partner dies.

Additional topics to be included in a partnership agreement, if applicable:

  • Admission of new partners: Indicate the process for admitting new partners into the partnership.
  • Right of first refusal: Specify that the partnership or individual partners will have the right to purchase a withdrawing partner's interest before the partner can offer to sell the interest to someone outside the partnership.
  • Duration of the partnership: Indicate the life of the partnership along with any events that may cause the partnership to dissolve prematurely.
  • Continuation of the partnership: Identify the criteria to enable the partners to continue the partnership if an event causing the dissolution of the partnership occurs.

Advantages of a general partnership.

  • Multiple owners: A partnership can have more than one owner, unlike a sole proprietorship.
  • Simplicity: A partnership is easy to form and operate.
  • Flexibility: A partnership is flexible enough to adapt to the business's changing needs.

Disadvantages of a general partnership.

  • Unlimited liability: Each partner is jointly and severally liable for all obligations of the partnership.
  • Ease of dissolution: A partnership dissolves upon the death or withdrawal of a partner unless safeguards are in place.

Forming a Limited Partnership

A limited partnership is a partnership with two classes of partners: general partners and limited partners. The general partners operate the business and are personally liable for all obligations of the partnership. The limited partners do not have any control over the business, other than to determine who will manage the business. Limited partners share in the profits of the partnership but their losses are limited to the amount of their contributions to the partnership.

A limited partnership is a creature of statute. As such, a limited partnership does not exist until the requirements specified in the state law are met. Generally, a certificate of limited partnership is required to be signed and filed with the secretary of state's office, and in some instances a limited partnership agreement is also required to be filed. If the requirements are not met, the business will be treated as a general partnership or an association taxable as a corporation.

A certificate of limited partnership contains information about the limited partnership such as its name, address, purpose, who the general partners are, and their business address, etc. The requirements of each state vary.

Limited partnership agreement contents. A limited partnership agreement contains the same basic information that a general partnership agreement does, but addresses some additional provisions pertaining to limited partners. A limited partnership agreement should address:

  • Contributions: Specify the amount and time of contributions to be made by each partner.
  • Management and control: Identify whether some or all of the general partners will manage and control the partnership.
  • Profit and loss sharing: Specify how the profits and losses will be allocated to the partners.
  • Distributions: Indicate when distributions of cash or property will be made.
  • Partner's responsibilities and duties: Describe the responsibilities of each general partner.
  • Withdrawal: Identify how a partner's interest will be valued if the partner withdraws from the partnership.
  • Death: Identify how a partner's interest will be valued if the partner dies.
    • Additional topics to be included in a partnership agreement if applicable:

      • Admission of partners: Indicate the process for admitting new general and limited partners into the partnership.
      • Right of first refusal: Specify that the partnership or individual partners will have the right to purchase a withdrawing partner's interest before the partner can offer to sell the interest to someone outside the partnership.
      • Duration of the partnership: Indicate the life of the partnership along with any events that may cause the partnership to dissolve prematurely.
      • Continuation of the partnership: Identify the criteria to enable the partners to continue the partnership if an event causing the dissolution of the partnership occurs.  
      Warning

      A limited partnership is generally not regarded as the best choice of entity for a new business because of the required filings and administrative complexities. For a new business with two or more working partners, a general partnership is much easier to form. If a limited partnership is needed at a later date, the general partnership can easily convert to a limited partnership.

      There are some situations in which a limited partnership for a new business may be desirable. One such instance is a business in which the owner needs to raise capital yet still control the way the business is operated. If that applies to you, you might consider forming a limited partnership and selling limited partnership interests to investors. 

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