Partnership Definition:
A legal form of business operation between two or more individuals who share management and profits. The federal government recognizes several types of partnerships. The two most common are general and limited partnerships.
If your business will be owned and operated by severalindividuals, you'll want to take a look at structuring yourbusiness as a partnership. Partnerships come in two varieties:general partnerships and limited partnerships. In a generalpartnership, the partners manage the company and assumeresponsibility for the partnership's debts and other obligations. Alimited partnership has both general and limited partners. Thegeneral partners own and operate the business and assume liabilityfor the partnership, while the limited partners serve as investorsonly; they have no control over the company and are not subject tothe same liabilities as the general partners.
Unless you expect to have many passive investors, limitedpartnerships are generally not the best choice for a new businessbecause of all the required filings and administrativecomplexities. If you have two or more partners who want to beactively involved, a general partnership would be much easier toform.
One of the major advantages of a partnership is the taxtreatment it enjoys. A partnership doesn't pay tax on its incomebut "passes through" any profits or losses to the individualpartners. At tax time, the partnership must file a tax return (Form1065) that reports its income and loss to the IRS. In addition,each partner reports his or her share of income and loss onSchedule K-1 of Form 1065.
Personal liability is a major concern if you use a generalpartnership to structure your business. Like sole proprietors,general partners are personally liable for the partnership'sobligations and debts. Each general partner can act on behalf ofthe partnership, take out loans and make decisions that will affectand be binding on all the partners (if the partnership agreementpermits). Keep in mind that partnerships are also more expensive toestablish than sole proprietorships because they require more legaland accounting services.
If you decide to organize your business as a partnership, besure you draft a partnership agreement that details how businessdecisions are made, how disputes are resolved and how to handle abuyout. You'll be glad you have this agreement if for some reasonyou run into difficulties with one of the partners or if someonewants out of the arrangement.
The agreement should address the purpose of the business and theauthority and responsibility of each partner. It's a good idea toconsult an attorney experienced with small businesses for help indrafting the agreement. Here are some other issues you'll want theagreement to address:
- How will the ownership interest be shared?It's not necessary, for example, for two owners to equally shareownership and authority. However, if you decide to do it, make surethe proportion is stated clearly in the agreement.
- How will decisions be made? It's a goodidea to establish voting rights in case a major disagreementarises. When just two partners own the business 50-50, there's thepossibility of a deadlock. To avoid this, some businesses providein advance for a third partner, a trusted associate who may ownonly 1 percent of the business but whose vote can break a tie.
- When one partner withdraws, how will thepurchase price be determined? One possibility is to agree on aneutral third party, such as your banker or accountant, to find anappraiser to determine the price of the partnership interest.
- If a partner withdraws from the partnership,when will the money be paid? Depending on the partnershipagreement, you can agree that the money be paid over three, five or10 years, with interest. You don't want to be hit with a cash-flowcrisis if the entire price has to be paid on the spot on one lumpsum.
