A partnership is an unincorporated organization with two or more partners. It is recognized as the simplest way for two or more people to own a business.
There are different types of partnerships, but partnerships are all designed to balance the risks and returns of the relationship. Negatives of partnerships include some loss of control and potential returns. Compared to corporations, partnerships are easier and less expensive to run, but they cannot issue stock or engage in corporate income splitting to lower tax liability. Sole proprietorships have similar advantages and disadvantages to partnerships, but are designed for individual entrepreneurs. The owner in a sole proprietorship would be solely and personally responsible for business debts.
Choosing the right partner is foremost to a good partnership. There are eight critical considerations for choosing the right business partner, Pamela Wasley, CEO of business management firm Cerius Interim Executive Solutions, wrote at Entrepreneur.
- Trust: Don’t partner with someone you wouldn’t trust with your personal bank account.
- Friendship: If you’re partnering with a friend, evaluate that person’s goals, values, responsibilities and personal life. If you have doubts, don’t do it.
- Trial Run: Do a trial run for a certain amount of time before finalizing the partnership.
- Partner, Employee or Consultant: Don’t partner with someone because you can’t afford to hire him or her.
- Varied Strengths: Bring in someone who complements your strengths.
- Balanced Responsibilities: Identify what responsibilities each party has and stick to them.
- Money: Money is always a major problem in a business partnership. Agree in the beginning how funding will be used and how profits will be distributed.
- Valuation/Contracts: A formula for how much the company is worth will be important should a partner decide to leave.
Partners should create a legal partnership document that spells out what will happen if someone leaves the company for any reason, including retirement, bankruptcy or death. Consulting a business attorney can be helpful for this important step.
Types of Partnerships
There are several different types of partnerships, and differences can vary depending on the state in which the business operates. Here are some general aspects of the three most common types of partnerships.
A general partnership is the default version of a partnership. Each partner represents the organization and has equal right to participate in the management, decision making and control of the business. In terms of risks and returns, the assumption is that profits are distributed equally and liability is shared equally. Debts or liabilities that impact the organization can be distributed equally.
A limited partnership involves one general partner with unlimited liability and all other partners having limited liability. Limited partners often have limited control over the company as well, the U.S. Small Business Administration notes, but this should be documented in the partnership agreement. Limited partners are not usually involved in day-to-day operations of the business. Profits are passed through to personal tax returns. The general partner must pay self-employment taxes.
Limited Liability Partnership
A limited liability partnership gives limited liability to every owner. This means that each partner is protected from financial and legal mistakes of the other partners. As a result, a limited liability partnership has some elements of both partnerships and corporations.
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