Whether you’re starting a business solo or with people you trust, your business structure is one of the most important choices that you’ll make. This decision will ultimately determine how your company forms and how you’ll run in the future. For many businesses with two or more owners, starting a general partnership is the best choice.
A business structure is best defined as the legal category you give your company. It tells the government, banks, and even investors about your responsibilities as a business owner, from how much you owe in taxes to who is in charge of your debt.
One of the simplest business structures to navigate is the general partnership, which naturally makes it one of the most popular options for co-owners. In this article, we’ll explain everything there is to know about general partnerships, including how they work and how they compare to other common types of partnerships.
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What Is a General Partnership?
A general partnership is the default business structure of any company with two or more owners who have chosen to do business together. Because there’s rarely any further action you’re required to take to legally start earning together, it is by far the fastest and most affordable way for partners to get their small business idea off the ground.
Within a general partnership, all business owners actively take part in managing your day-to-day business operations. Each individual partner has the power to make legally binding decisions on behalf of the entire company.
How General Partnerships Work
Now that you know the basics of how general partnerships work, we’ll dive further into what it takes to form this type of business entity. We’ll also go over how general partnerships can affect you legally and financially.
Formation
General partnerships come with the lowest startup costs out of any business structure for two or more people. As we mentioned in the section above, formation is as easy as agreeing to work together.
Much like sole proprietorships, which are run by a single owner, general partners may be required by some local laws to obtain business licenses, but this is rarely needed. Only when you’re planning on hiring people outside of your partnership do you need to get an Employer Identification Number (EIN). An EIN is a special taxpayer identification number that can help you get loans, business bank accounts, and local permits.
There is an extra step that general partners usually opt to take that sole proprietors don’t have to worry about: creating a partnership agreement. Though not legally required in most states, the partnership agreement is a legally binding document that offers many benefits. Your agreement can:
- Define the roles of each co-owner
- Divide profits and voting rights
- Settle disputes
- Create a business name (which is otherwise the last names of each partner by default)
- Describe what happens when a partner exits the business or passes away (your company otherwise dissolves by default)
This document is created manually by you and your partners (though you can find partnership agreement templates online), so it can take time. However, it still doesn’t cost you any money to create.
Liability
One of the main aspects of general partnerships that you should be extra cautious about is the amount of personal liability it places on you.
Within a general partnership, you and your co-owners do not operate as separate entities from your business. This means that any business debt accrued directly impacts your personal credit scores and any lawsuits your business receives are lawsuits against you. Your company’s legal or financial obligations can put your personal assets at risk.
When it comes to your business decisions, you’re not separated from your co-owners in any way either. Partners share the responsibility of any action one takes. Whether a partner has signed a contract or gotten your company involved in illegal activity, you will be held accountable in some way.
In this sense, starting a general partnership leaves you with unlimited personal liability and can become risky business if you’re not working with people you fully trust.
Taxes
A big draw of general partnerships is the fact that they are never taxed twice. While most owners of corporations are required to pay both their business income tax and their personal income tax, partnership profits instead pass through to the owners of the company. Because of this, each partner will simply pay personal income tax for their share of the profits. This is often known as “pass-through taxation.”
The only legal document your partnership will have to file for taxes each year is Form 1065. This form simply tells the Internal Revenue Service (IRS) how much the business has earned and confirms that profits have been split up as agreed upon.
General Partnership vs. Limited Partnership
Another common type of partnership is the limited partnership (LP), in which you have a combination of general partners and limited partners owning a business. General partners in an LP have the exact same responsibilities and liabilities as general partners in a standard partnership. Limited partners, on the other hand, experience an entirely different form of ownership.
Rather than taking an active role in the organization, limited partners take a step back and don’t have much decision-making power. They may still get equal profits, unless otherwise stated in the partnership agreement, but the biggest draw of becoming a limited partner is the fact that you get liability protection from any business obligations.
To form an LP, you will have to take an extra step and file a Certificate of Limited Partnership with your state. This document comes with a filing fee that can be as little as $25 or as much as $200. Still, LPs are comparatively cheap to maintain in the long run and enjoy the same pass-through taxation that general partnerships get.
General Partnership vs. Limited Liability Partnership
A limited liability partnership (LLP) is a company that’s fully made up of limited partners. This means that none of the owners are responsible for business obligations. Plus, all partners are protected from lawsuits caused by another partner’s negligence. As a result, LLP owners risk their assets far less than general partnership owners.
Despite being limited partners, LLP owners are able to play active roles in the business due to the absence of general partners. Unless otherwise agreed upon, you have equal say in the management of your company, just as you would in a general partnership.
Forming an LLP does require the filing of a Certificate of Limited Liability Partnership within your state, which comes with a filing fee.
Frequently Asked Questions
Now that you have all the information you need to know about general partnerships, you can decide if it’s the best business structure for your new company. To help you decide, here are a few frequently asked questions:
1. Can I choose to create a sole proprietorship with my business partner instead of a partnership?
In most cases, business partners do not have the option to create a sole proprietorship, which is a type of business entity that’s typically reserved for individuals. The only exception to this rule is if you’re operating your business as a married couple. In this scenario, your business is a sole proprietorship by default if you file a joint tax return and operate as co-owners. If you don’t file a joint tax return, your business is still a partnership by default.
2. Can I easily get investors with a general partnership?
General partnerships are not usually considered good candidates for investments. Since you and your partners are not separate entities from your business, the investor is put at greater risk, due to the fact that they must trust that your personal assets will cover your debt. Plus, they’ll only have your personal credit scores to go off of for gauging the likelihood that you’ll pay them back.
For this reason, general partnerships may find issues getting basic bank loans as well, so if your business model depends on raising a lot of capital, this may not be the best business structure for you.
3. Do I need to complete any annual requirements to remain a general partnership?
Other than filing Form 1065, you don’t have to do anything to maintain your general partnership. This is a big perk that this business structure gives over corporations, which require owners to complete meeting minutes, have a board of directors, fill out annual reports, and more.
Launch Faster With a Partnership
Forming a general partnership is one of the easiest routes you can take to start operating a business with your partners. You will be faced with quite a bit of financial and legal liability, but if you work with people you trust, draw up a partnership agreement, or work in a low-risk industry, this can be a great, low-cost option. In the long run, general partnerships are also a lot less stressful to maintain than many of your alternatives.
If your team still isn’t sure about forming a partnership of any kind, you may want to consider creating a limited liability company (LLC), which is also a great option for solo entrepreneurs. Read our partnership vs. LLC comparison to weigh the differences.
