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ENTREPRENEUR RESOURCE CENTER
Business Legal Structure: Partnership
A partnership (General and Limited Liability Partnership/LLP) is usually defined as an association of two or more people carrying on as co-owners of a business. Partnerships come in two varieties: general partnerships and limited partnerships. In a general partnership, the partners manage the company and assume responsibility for the partnership's debts and other obligations. A limited liability partnership (LLP) is simply a general partnership whose partners enjoy some protection from personal liability and it usually has general and limited partners. The general partners own and operate the business and assume liability for the partnership, while the limited partners serve as investors only. They have no control over the company and are not subject to the same liabilities as the general partners.
The advantages of a partnership:
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Easy to establish. Much like proprietorship, the general partnership is easy and inexpensive to establish. The partners must obtain the necessary license and submit a minimal number of forms. |
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Complementary skills of partners may create a synergy that is critical for the success of the business. |
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Division of profits usually follow the partnership agreement. |
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Larger pool of capital. Each partner's asset base will contribute to enlarge the borrowing capacity of the business. |
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Flexible enough to make quick responses to opportunities in the market. |
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A partnership does not pay tax on its income but "passes through" any profits or losses to the individual partners. At tax time, each partner files a Schedule K-1 form, which indicates his or her share of partnership income, deductions and tax credits. In addition, each partner is required to report profits from the partnership on his or her individual tax return. Even though the partnership pays no income tax, it must compute its income and report it on a separate informational return, Form 1065. Personal liability is a major concern if you use a general partnership to structure your business. Similar to a sole proprietorship, general partners are personally liable for the partnership's obligations and debt. |
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In addition, each general partner can act on behalf of the partnership, take out loans and make business decisions that will affect and be binding on all the partners (if the general partnership agreement permits). Keep in mind that partnerships are more expensive to establish than sole proprietorships because they require more extensive legal and accounting services. |
The disadvantages of a partnership:
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Unlimited liability of at least one partner. At least one member has to be a general partner which has unlimited personal liability. |
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Capital accumulation. A partnership still has limitations in raising and sharing the needed capital. |
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Restrictions for elimination of general partnership. There may be a restriction on how partners can dispose their share of the business. |
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Usually they have to sell their interests to the remaining partners. |
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When general partner dies, becomes incompetent or withdraws from the business then the partnership will dissolve, although it may not terminate. |
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Lack of continuity for the general partnership. |
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Personality and authority conflicts can occur among partners. |
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Limited partners lose limited liability if they participate in the daily operation of the business, and the LLP must pay an annual fee to the state based on the number of partners. Also, in certain states, LLPs are only available for particular types of businesses, such as law and accounting firms. |
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In the U.S., states that have enacted LLP legislation to date are Arizona, Connecticut, Delaware, Illinois, Iowa, Kansas, Kentucky, Louisiana, Maryland, Minnesota, New York, North Carolina, Ohio, South Carolina, Texas, Utah, Virginia and the District of Columbia. You can form an LLP by filing the appropriate papers with your state. Each state has its own application process, so consult a legal adviser to determine the proper application method for your state. |
For a guidance, a partnership agreement should answer the following questions:
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What is each partner's investment? Is one investing cash and the other energy? |
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Do any of the partners own equipment that you'll use in the business, and does that fact deserve consideration as part of the start-up investment? |
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What are the responsibilities and duties of each partner? Be specific about each partner's role in the day-to-day operations of the company. |
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If a partner becomes disabled, how long will he or she get a share of the profits? If a partner dies, what happens to that share? A good way to deal with this issue: life insurance on all partners. |
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Can the partners have other outside partnership interests? In particular, can interest be in similar or competitive businesses? |
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What will you do if one partner wants to withdraw? Typically, you'll set up a buyout agreement, but it's a very good idea to decide on the terms before the situation arises. You'll also want to include a non-compete covenant. |
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How will you restrict partnership-interest transfers? Can a partner transfer his or her ownership to anyone, or can you limit that transfer? This means the remaining partners won't find themselves in partnership with someone they object to. This is frequently used to protect the business in the event that one of the partners gets a divorce and his interest becomes a part of the divorce settlement. |
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Can a partner pledge his or her interest as collateral for a loan? |
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Are additional contributions mandatory? If the business needs capital in the future, are partners required to make capital contributions? |
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How will conflicts be resolved? Most often, an arbitrator is used. |
For more information, please refer to:
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