Business Partnership: Simple to Start but Sometimes Risky

Small Business
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General Partnerships: Easy to Form but Lots of Liability

A business partnership is the simplest way to structure an entity that has more than one owner. If you’re starting an ice cream truck business with a friend and are each putting in half of the startup’s funds, that’s a partnership.

Sounds simple, right? Not so fast. Every business, at some point in its life, will have outsiders demanding money from it, perhaps from a contractual obligation or a lawsuit. The kind of partnership you set up — if a partnership is the business structure you want, and it may not be — will determine if and to what extent your personal assets are protected from creditors.

The choice you and your co-owners make could be critical to the health of both your business and your personal finances.

What is a business partnership?

A partnership is an unincorporated business owned and run by two or more people known as partners. Every partnership, in the eyes of the IRS, is a pass-through entity, which means the business itself is not taxed on its profits. Rather, all profits “pass through” to the owners, who file them on their own tax returns.

Types of business partnerships

Different types of partnerships provide varying levels of personal liability protection for partners.

A general partnership is the simplest. It has only general partners, who share equally in the ownership and management duties of the business. A GP is easy to set up, but it’s risky because you and the business are one and the same. You’re each jointly and severally liable for what’s owed, meaning creditors can come after any partner individually for the entire amount.

A limited partnership has general partners and limited partners, who own stakes but aren’t involved in the day-to-day grind. An LP protects limited partners’ personal assets up to the amount they invested in the business. General partners, meanwhile, can be held liable in the same way as they are in a GP.

A limited liability partnership is yet another variation on the model in which each partner’s personal assets are protected against the debts of the business, but partners can still be held personally liable for their individual professional actions. LLPs are used by licensed professionals such as lawyers, doctors and accountants. In fact, California and New York require that partners in an LLP be licensed in the state to provide a professional service.

A limited liability limited partnership is available in at least 23 states and is a variation on an LP that extends protection of personal assets to general partners, in addition to limited partners.

Business partnership: The pros

Here are some advantages to structuring as a partnership.

Easy and inexpensive to form

You don’t have to file paperwork with your state to start a general partnership; it’s automatically in place as soon as you and your partner go into business. For the other kinds of partnerships, states generally require partners to submit forms and pay a fee upon formation, then submit additional paperwork and fees annually.

Federal tax simplicity

Partnerships must file an annual information return with the IRS to report their income, but the income documented in the return is not taxed. Because a partnership is a pass-through entity, profits go directly to the partners and are included on their individual income tax returns. If the business is in an early stage and operating in the red, you can write off those losses on your personal return. If you’re in the black, the profits add to your individual tax bill.

Business partnership: The cons

Personal liability risk

For GPs and LPs, you and your general partners open your personal assets up to significant risks. Creditors can pursue any partner individually if you have unpaid debt.

Shared ownership can get complicated

Once you form the business with other partners, you’re bonded to those people until that relationship ends. While different kinds of partnerships specify different roles between general and limited partners in terms of operational control, every partnership involves some degree of collective decision making, which can become difficult if partners disagree.

“Having a business partner is very much like a marriage,” said Elliot Richardson, CEO and founder of the Chicago-based Small Business Advocacy Council. “Just like a marriage, that can end well or that can end in a messy way.”

Experts recommend creating a partnership agreement that outlines how to handle responsibilities and conflicts within the business.

How to get started with a business partnership

  • Name your business: The default legal name of your partnership is the combination of the last names of its partners. If you would like to operate under a different name, it’s best to register a DBA, or “doing business as,” name with your county or state. These are also known as fictitious names, assumed names or trade names.
  • Get an employer identification number: The IRS requires any business operating as a partnership to have an EIN, a nine-digit number assigned to a business for tax purposes. You can apply online for an EIN.
  • Get proper business licenses and permits: States regulate the conduct of many types of businesses, so you’ll need to determine which licenses, if any, your business needs to operate legally. Each state has an agency or office that handles professional licensing.
  • File appropriate formation paperwork with your state: This step is generally required for partnership types other than GPs. In Illinois, for example, LPs must file a certificate of limited partnership to do business.
  • Create a written partnership agreement: You’re not legally required to draft a partnership agreement, but it’s a good idea to have one. Doing so can help you and your partners avoid potential issues or disagreements down the line. It should outline how you and your partners will share responsibilities, split profits and losses, resolve disagreements, change ownership and dissolve the partnership.
  • Comply with publication requirements: Many states require some types of partnerships to publish their formation in newspapers. In Arizona, partnerships with “liability” in the name — LLPs and LLLPs — must publish in “a newspaper of general circulation” for three consecutive publications within 60 days of filing.

Learn how to start your business

NerdWallet has rounded up some of our best information on starting a business, including structuring and naming your company, creating a solid plan and much more. We’ll help you do your homework and get started on the right foot.

 

Andrew L. Wang is a staff writer at NerdWallet, a personal finance website. Email: awang@nerdwallet.com. Twitter: @andrew_L_wang.

Updated July 28, 2017.