In a general partnership, at least two people share ownership and each owner is liable for debts and liabilities associated with the business. This is not to be confused with a limited partnership, in which a managing partner has liability while silent partners enjoy liability protection.
In this article, we’ll outline everything you need to know about general partnerships. We’ll cover some of the benefits and downsides of choosing this business structure and provide a step-by-step guide to help you determine whether a general partnership is the best option for your business.
What is a general partnership?
The general partnership definition is an unincorporated business with more than one owner. The owners of the company share responsibilities and obligations, most noticeably business debts. Owners share unlimited personal liability for business debts. Additionally each owner in a business partnership must report their share of profits and losses on their personal income tax return.
The benefits of general partnerships
One of the most significant benefits of general partnerships is how easy they are to set up. Unlike a limited liability partnership (LLP), corporation or limited liability company (LLC), you don’t need to register with your respective Secretary of State’s office to form your company. As a result, you also don’t need to submit a filing fee. Much like sole proprietorships, many states recognize general partnerships as soon as business activity begins.
The other benefit of a general partnership is that it’s easy to convert them to another business structure. For instance, if you eventually wanted to switch to an LLC for more liability protection, all you generally need to do is provide conversion paperwork to your local Secretary of State’s office.
The downsides of general partnerships
Although it’s easy to form a general partnership, they also come with some disadvantages. The most alarming is the fact that you and your other partners are responsible for all debts of the business. This means that creditors can come after yours and your partners’ personal assets in the case that the company falls behind on payments or other obligations to suppliers and lenders.
The other primary downside of a general partnership is that ownership can quickly become complicated. This may especially be the case if there are only two partners who own the company equally. Most experts recommend that you include a partnership agreement when forming your business, which we’ll touch on more below.
Forming a general partnership
If you think a general partnership is right for your small business, here’s how to get started.
1. Choose a name for your business
Choosing a name for your new partnership is a critical task. This is the name that will represent your firm’s services to the world. The default name of your company is the surnames of all partners. For instance, if Bob Smith and Susanne Jones go into business together, the partnership name is “Smith & Jones” by default.
This is often not an attractive name for a business, mainly because it doesn’t indicate what type of company you’re running. So if you want to operate under something more appropriate, such as “S&J Interior Design,” then you’ll need to file a Doing Business As name with your local secretary of state’s office.
Many states prohibit the use of “same” or “similar” names for many types of business entities. So, before diving in and ordering stationery and business cards, make sure your name is available. Keep in mind that even though there might not appear to be a direct match, it’s up to the discretion of the secretary of state as to whether your proposed name is too similar to another name, and will therefore be rejected for use.
There are as many as three different places where you can check the availability of a business entity name:
- Local County Registrar: Your local county registrar has a database of registered names you cannot use.
- Secretary of State Office: Many Secretary of State offices provide name-availability and name-reservation services. Some states allow you to check online, whereas others require you to submit a request to search for name availability by mail.
- The United States Patent and Trademark Office: Consider whether you’ll want federal or state trademark protection for your partnership name. Even if you don’t need trademark protection, it’s worth your time to look up the names of other firms with the United States Patent and Trademark Office. If another entity has a registered trademark using your name or a similar name, you may receive a letter from a third party claiming you’ve violated their registered trademark and requesting you cease from further use of the name.
2. Create a partnership agreement
Once you establish your business name, you’ll want to draft a partnership agreement. All individual partners with an ownership interest should sign and review this agreement. This step isn’t required by law, but it can go a long way toward helping diffuse conflicts that could arise between partners in the future. The partnership agreement form should be detailed and should cover:
- The name of the partnership and the type of business it is
- The purpose of the partnership
- The fictitious business name if there is one
- How partners share responsibilities and the ownership percentage of each
- The capital contribution that each partner made
- What will happen in the case of additional partner contributions
- How partners determine their share of the profits
- The ways in which partners split losses, debts, and other liabilities
- The management duties of partners
- Who will settle disagreements
- What actions warrant losses of the partnership
- How to pass or change ownership
- The monetary amount required for a buyout
- What needs to happen to dissolve the partnership
- What occurs in the case of the death of a partner
- How to divide the assets of the partnership upon dissolution
When you initially start your business, everything may seem grand and optimistic. This could especially be the case if you start it with family or close friends. But, you should still put a partnership contract in place to protect yourself against the actions of the other partner—while allowing them to do the same. The contract should protect both you and your partners’ interests.
The best-case scenario is that you never have to enact anything in the agreement. But, in the unfortunate situation that you do, you’ll be glad you have it in place. Contact a trusted legal firm to draw up a partnership agreement for you. Make sure both parties are satisfied with the agreement before continuing. The agreement is a legally-binding document. Once signed, both parties must abide by its terms until they sign an addendum.
You should also draft a new business partnership agreement anytime you add new partners to the firm.
3. Secure an Employer Identification Number
The term “partnership” refers to how many owners the business has. You can hire employees to work for you that aren’t owners or partners. If this is the case, you’ll want to secure an Employer Identification Number from the IRS. Doing so allows you to pay employees and pay business taxes.
4. Open a bank account
Once you’ve secured your EIN, you can open your new partnership bank account. Most banks will require your EIN to open your business bank account. Additionally, banks may request copies of your DBA and partnership agreement.
5. Secure licenses and permits
Your new business may need to secure various licenses and permits. You may not only need to do so at the local level, but at the state and federal levels as well.
Failure to apply in a timely manner may subject the partnership to fees and penalties. If severe—for example, you’re running a bar without a state-approved liquor license—then your business could be shut down, and you and your partners could face legal action.
If your partnership will be selling or leasing personal, tangible property, or selling taxable services at retail or wholesale, all states require you to obtain a seller’s permit unless the property or services involved are exempt from sales or use tax. Follow up with your local Secretary of State’s office to ensure you meet all obligations before you begin conducting business.
6. Maintain other regulatory and tax requirements
As a general partnership, you won’t have to file an annual report each year, as LLCs and corporations often must. However, there are still regulatory steps you need to take to ensure business compliance.
If your partnership plans on hiring employees, you will likely be subject to payroll withholding tax at the local, state and federal levels. You also may need to meet annual workers’ compensation insurance obligations, which can include providing proof of insurance annually. Additionally, you may need to renew your business permits and licenses each year.
Check with the IRS, your state employment development department, the division of workers’ compensation and other employment-taxing authorities to determine what your obligations are.
Lastly, recall that you’ll need to pay taxes on any income earned as a partner. Partnerships are not subject to the corporate tax rate. Instead, all partners report proportional income on their personal tax returns. For instance, if partners share a 60/40 stake in the company and the firm must report $100,000 in income, Partner A would report $60,000, and Partner B would report $40,000. They would both do so on IRS Schedule K.
Get started forming a general partnership
Many business owners are attracted to partnership businesses because of how easy they are to form. If you’re comfortable carrying unlimited liability, then a partnership could be right for you. Some companies—say, a graphic design business—may not have as much need for liability protection as others, like a doctor.
Before registering with your local secretary of state’s office, we recommend contacting a trusted law firm for legal advice. Lawyers can help with the business decision-making process. They can also help you properly draw up legal documents like a general partnership agreement.
Because you’re taking on unlimited liability, you’ll want to invest time to ensure you complete all legal documents correctly. If you do so, you’ll put your partnership in a much better position for success moving forward