Find out what a partnership is in business and if you should start one.
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A business partnership is exactly what it sounds like: a business that is owned by two or more people. In this type of entity, each business partner shares in the company’s profits and losses.
As we already mentioned, a business partnership is a business that is owned by two or more people or companies. Each business partner invests their own money into the business, and shares in the company’s profits and losses.
Partnerships typically must register with the state in which they are formed/do business. The regulations for how to form a partnership and what types are an option vary from state to state. Check with your Secretary of State to make sure you follow the rules for your area.
If you’re forming a general partnership, the steps typically include:
Learn more about forming a business partnership.
The way a business partnership works depends on what type of partnership it is. There are three basic types of business partnerships. They include:
A general partnership (GP) is one in which the partners work in the business and are heavily involved in day-to-day company management and business decisions. In this structure, partners are liable for business debts and lawsuits brought against your business.
In a limited partnership, one or more partners are responsible for managing the company and have liability for business debts and lawsuits, while the other partners aren’t involved in business operations and don’t have liability for debts and lawsuits.
Finally, a limited liability partnership protects all partners from the actions or debts of the other partners in their business. This structure is often selected by professionals in the fields of accounting, law, healthcare/medicine, and architecture.
Note: While a limited liability partnership provides liability protection from the actions or debts of your partners, it does not protect you from liability for your own actions, or lawsuits brought against you.
Different types of business partnerships may have different levels of partnership participation and hierarchies. This means that partnerships can have several different types of partners within one partnership.
Examples of the different kinds of partner roles you can create include:
General partners participate in the operations and management of your business within the partnership. They also have personal liability for the business’s debts.
Limited partners invest, often financially only, in the business. However, they don’t usually participate in the daily management and running of the company.
Equity partners have a share of ownership in the overall partnership and its business assets.
Salaried partners are also treated as employees and may or may not have ownership shares.
Junior and senior partners are different levels of partnership roles. Each of these partnership types has different duties, levels of management input, responsibilities, and financial investment commitments.
Unlike corporations, partnerships are not separate entities from their owners for tax purposes.
At tax time, partnerships file a Form 1065 with the IRS, also known as an information return. Taxes are not paid by the partnership itself. Instead, each partner reports their share of the company’s profits and losses on their own individual tax return. This means partnerships are treated as pass-through entities.
Partners receive a Schedule K-1 which shows their business tax liability from the previous year. The K-1 will be included with each partner’s additional income on their individual tax return.
There are several advantages to forming a business partnership.
Most types of partnerships are easy to form, manage, and run. They often have fewer restrictions and regulations than corporations and other types of business structures. Partnerships do not have to conform to specific business structure laws because the partners involved create their own laws and rules about how the business will be managed. Management is also more flexible and simply needs to abide by the partnership agreement.
Most startup partnerships are funded by the individual partners’ investments in the business. The more partners involved, the greater the startup funding. This allows for more financial growth and working capital. It can also lead to bigger marketing budgets, resulting in even higher profits.
The combination of each partners’ credit scores and assets also gives new partnerships better borrowing capacity to acquire funding.
The income splitting and pass-through of business losses for partnerships can help offset high tax brackets for many individuals.
Multiple partners share in the daily operations of the company. This allows each person to bring their best abilities to the business’s success. Smart partnerships split the management responsibilities according to each person’s skills and aptitudes. If you’re good with accounting, you should handle the bookkeeping and reporting. A partner who is good with sales might serve as the sales director.
You and your partners will share the decision-making process, which will help to make better decisions in difficult business circumstances. Having many expert minds means greater access to smart business ideas and problem-solving expertise.
You and your business partners’ affairs are kept private because you do not have to file the required annual financial statements that corporations must.
With all the pros of a business partnership, there are also some cons and potential pitfalls. They include:
Partners who are not part of an LLC or are specifically limited partners will be at risk for the liability of all business debts and court judgments.
Most partnership agreements also include the stipulation that each partner is jointly and severally (which means equally) liable for the debts of the partnership. This means that each person is liable and responsible for their divisible share of the business debts and also liable for all the debts as a total.
The risk of friction among partners over financial and business matters can be a major disadvantage of partnerships. The best way to avoid this risk is to write a detailed partnership agreement stipulating everyone’s agreement over roles, responsibilities, business management, and financial investments.
Your partners’ actions can reflect on you from both a liability and reputation-based standpoint. That’s why it’s important to only go into business with people or business entities that you trust and that offer full transparency.
If a partner leaves or joins the partnership, the business and partnership assets must be revalued redistributed. This can be costly and time-consuming.
In summary, partnerships are business entities that are owned by two or more people. There are three distinct types of partnerships:
Within each of these structures, you also have the option of appointing several different kinds of partners who play a varying degree of roles within your company operations.
For tax purposes, partnerships are treated as pass-through entities, in which each partner reports their share of company profits and losses on their individual tax return.
Meanwhile, the disadvantages of a partnership are often:
Remember, if you have any questions or needs surrounding starting a business, we can help. From our business formation services to worry-free compliance, we’ve got you covered. Reach out to us today. We can’t wait to help you start, run, and grow your dream business!
Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
Partnerships are often a good choice for businesses with multiple owners, or those in professional industries such as attorneys and architects.
The way a partner is paid depends largely on what type of partner they are. For instance, a salaried partner might be paid an exact salary much like an employee. However, a general partner would generally be paid based on their ownership share in the business congruent with the business’s profits and losses.
Partners own and play an active role in managing the business, whereas stakeholders may simply be investors or others who are affected by the success or failure of a company, but who do not play a role in managing or running the business.
The main types of business ownership include: