Wondering how to form business partnerships with two or more people to start or grow your company? Learn about the different types of partners and partnerships, their differences, advantages, and disadvantages to make your best decision for new business startup.
Definition of a partnership business
What is a partnership in business?
A business partnership is similar to a personal partnership or marriage where individuals decide to:
- combine financial resources to start a profitable business
- share their talent, time and skills towards their common objective of business success
- participate in the ups and downs, successes and failures of their enterprise.
Business partnerships are a specific type of, legally binding, the business entity that is formed by the partnership agreement, accepted by two or more individuals, who are the businesses co-owners.
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A multiple owner partnership business structure is where each owner invests either time, talent, and money into the company. In some partnerships, individual co-owners work in the daily operations business. While other partnerships include partners with limited participation and also limited liability for the company’s debts and lawsuits.
Partnerships differ from other business structures, such as corporations, because they are not a separate entity outside of the original owners in the eyes of the law. The partnership share of income tax is paid by the partners. The profit and losses of the company are divided, according to the percentage of ownership, amongst the partners and listed on their individual personal tax returns.
This means that this type of business entity, like a DBA or sole proprietorship, and some forms of subchapter S corporations, is a pass-through business. This means that all the profits and losses of the company will pass through to the owners’ personal financial income tax statements. Set up your Partnership expertly and affordably at LegalZoom.
Types of partnerships and partners
Note that there are both differences between both types of partners within partnerships and the legal business entities of partnerships. Read on to learn about their important differences before you form your partnership.
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. These are the different types of partners roles you can create:
- General partners will participate in the operations and management of the businesses within the partnership and additionally have personal liability for the debts of the partnership.
- Limited partners will invest, often financially only, in the business partnership concerns, but usually does not 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 partners that are also 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.
Types of partnerships
The first step in creating your partnership is to decide the type of partnership that you want for your new business:
- General partnership consists of partners and owners who participate daily in the management and operations of the company’s held within the partnership, and also have liability as business co-owners for any debts and lawsuits that the business may incur.
- Limited partnership has one general partner who is the business manager and one or more other individuals who are limited partners who do not participate in the daily running of the business and also do not have personal liability for the company’s debts.
- Limited liability partnership is similar to the limited partnership described above. However, it often has several general partners, not just one who is responsible for the daily business operations.
Advantages and disadvantages of partnerships
Advantages of partnerships
- Flexibility – most types of partnerships are easy to form, manage and run, especially if you use my recommended vendor LegalZoom for your partnership formation (save 10% with our exclusive promo code BEST4B19). They are less strict and much less regulated than corporations and other types of business structures. They do not have to conform to specific business structure laws because the partners involved essentially create their own laws and rules about how the business is to be managed within the partnership. Management is also more flexible and only needs to have the partners agreement.
- Finances – most startup partnerships are funded by the individual partner’s investment in the business. Thus, the more partners involved, the greater the startup funding. which allows for more finances for growth and working capital. Ultimately greater profits can be generated with this larger marketing budget.
- Credit – a greater borrowing capacity is achieved by combining all of the partner’s credit scores and asset bases, which is a major advantage of business partnerships.
- Tax Savings – many partners join into business partnerships specifically for the tax saving advantages due to income splitting and pass through business losses to offset high tax brackets for individuals.
- Responsibility – multiple partners share in the daily operations of the company. This allows each person to bring their best abilities to the businesses success. The smartest partnerships split the management responsibilities according to each person skills and aptitudes. If you’re good with accounting, you should handle the bookkeeping and reporting and your partner who is good with sales and should be the marketing director.
- Decisions – 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.
- Privacy – you and your business partners affairs are kept private because you do not have to file the required annual financial statements that corporations must.
Disadvantage of partnerships
- Liability Risk – unfortunately partners who are not part of an LLC or are specifically limited partners will be at risk for the liability of all debts and court judgments of the businesses contained in the partnership.
- Debt Responsibility – most partnership agreements include the stipulation that each partner is jointly and severally 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.
- Disagreements – the risk of friction and animosity amongst partners over financial matters and business management 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. Get expert and affordable legal help to craft your partnership agreement at Legalzoom who has helped millions of partners launch businesses and save 10% with our exclusive promo code BEST4B19
- Partner Actions – the partnership is viewed as a whole body in the eyes of the law and thus each partner is liable for the other partner’s actions which could be fraudulent or illegal.
- Departure and Arrival of Partners – if one or more partners decide to either leave or join the partnership, the partnership assets, the business or businesses, needs to be revalued and each partner shares redistributed. This can be costly and time-consuming.
How to form a business partnership
Most business partnerships are registered with the state in which their business is headquartered. However, state requirements vary for registration law. Partnership agreements, which clarify the relationships between the co-owners, partners, and investors is generally required as part of the formation process. These partnership agreements are a written, legally binding contractual agreement. However, they are not a requirement in all business circumstances.
The business law states that our courts will determine if a partnership, formally registered or not, was the rightful business owner by determining if there was sharing of profits and losses, capital investments by partners, joint control, and management of the business and common ownership of business assets.
Depending on your state. You may have multiple choices of the types of partnerships available for your business entity structure.
How to join a partnership
Most partnerships allow individuals to join at the beginning or after the partnership has been formed and is in operation. The new partner must invest in the partnership, either financially or with talent and time as their admission fee. The amount of money and other details, including the liabilities share will be determined by the other partners and the written partnership agreement that was created at the onset of partnership formation.
The importance of your partnership agreement
Your partnership agreement is amongst your most valuable assets as a partner. It will describe all the responsibilities of each partner and detail that partners share distribution for both profits, losses, and liabilities. Additionally, it will detail the roles and expected contribution of both time, talent, and money for each individual.
Good partnership agreements also outline actions for typical situations such as member, divorces, death, business closures and acceptance of new partners.
How a partnership pays income tax
The partnership itself as a business entity does not pay income tax unlike some forms of corporations do. Instead, the individual partners will pay taxes based on their share of either profit or loss of the business operations in the stated tax year.
Partnerships file an information return with the IRS form number 1065. Limited liability companies LLCs that have multiple members will file their income tax as a partnership. Each state has differing tax filing requirements, check with your Secretary of State for your state’s laws.
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