Deciding how to legally structure your business is one of the first steps to forming a new company. Your business’s structure informs how you’ll pay taxes and to what extent you’ll be personally liable for company debts or lawsuits. When you’re just starting out, a general partnership can be a good business structure to consider because it’s easy and inexpensive to set up. However, general partnerships also saddle the partners with a lot of personal liability.
Overview of general partnerships
A general partnership is an unincorporated business owned and run equally by two or more people known as general partners. Each general partner shares responsibility for the business’s profits, losses and debts, and managing the business day to day.
If you’ve agreed to go into business with another person, you’re already running a general partnership. You don’t have to register with state agencies to officially form one, unlike limited liability partnerships (LLPs), limited liability companies (LLCs) and corporations.
A general partnership is easy to set up, but it’s also risky because as a general partner, you and the business are one and the same; if the business gets sued or owes money to creditors, it’s as if you get sued or owe creditors. In a general partnership, you’ll also face the challenge of splitting responsibilities, profits and losses with the other partners, unlike in a sole proprietorship, where you’d have full control of business decisions and full responsibility for your business’s financials.
Even if you go into business with a family member or your best friend, it’s smart to create a partnership agreement, a legal document that spells out each partner’s’ rights and responsibilities in the business. Creating this agreement at the beginning of your partnership will help you and your partners think through tough questions like “How will we split profits and losses?” and “What happens if one partner leaves the business?” Putting answers to these questions in writing can help you prevent future conflicts, or at least provide a framework to help you and your partners settle disagreements when they arise.
If you want to go into business with a partner, starting as a general partnership is a good strategy. It’s easy and inexpensive to form, which will save you time and money while you focus on other aspects of starting your business, such as writing a business plan, acquiring funding and finding customers. However, it will likely make sense for you to consider forming an LLC or corporation later on to decrease your personal liability.
Advantages of general partnerships
- They’re easy and inexpensive to form. You don’t have to file paperwork with your state to start a general partnership; it’s automatically in place as soon as you and your partner go into business.
- It’s a straightforward process to convert to another business structure. Since general partnerships don’t require much paperwork, it’s easy to change one to another business structure if you so choose. For example, say your business starts as a general partnership, but two years in, you decide to form an LLC to decrease your personal risk. The conversion process differs by state, but generally it involves dissolving the general partnership and filing paperwork to form an LLC, or simply filing conversion paperwork.
Disadvantages of general partnerships
- You and your partners carry a large amount of personal liability. You and the other general partners are personally liable for all of the business’s debts and lawsuits, and the actions of the other partners. If your business doesn’t pay your supplier or lender, you and your partners are responsible for those debts, and creditors can go after your personal assets, including your home or car.
- Shared ownership can get complicated. A partnership is like a marriage; all partners have equal ownership and decision-making responsibilities, which can become difficult if you and your partners disagree. Experts recommend creating a partnership agreement to formally outline how to handle responsibilities and conflicts within the business.
NerdWallet verdict
You should consider structuring your business as a partnership if you’re a new business and want to test your concept before putting time and money into incorporating. Once you’re committed to the business, give serious thought to converting the partnership to an LLC, LLP or a corporation to lessen your personal risk for the business’s debts and losses.
You shouldn’t form a partnership if your business inherently deals with issues of liability, such as in a medical practice or a roofing company. If your business gets sued, you and the other general partners are personally responsible for paying any damages, and creditors can go after your homes, cars and other personal assets.
How to get started
- Name your business. The name of your partnership is automatically the surnames of all partners. For example, if your name is Sue Johnson and you and Bob Green open a flower shop together, your business is legally called “Johnson & Green.” To do business under a different type of name, you have to register a Doing Business As (DBA) name to claim your business’s fictitious or assumed name. To extend the previous example, you and Bob would have to register with your state government to be able to go into business using the name “Flowers-R-Us.”
- Get the proper licenses and permits for your business. Depending on your state, locality and industry, you need certain licenses and permits to legally operate. Use the SBA Business Licenses and Permits search tool to find links to the relevant paperwork you’ll need.
- Create a written partnership agreement between all partners. A General Partnership agreement isn’t legally required, but it’s highly recommended as a way to document the terms of your partnership and the expectations of all its general partners. Your general partnership agreement should outline how you and your partners will share responsibilities, split profits and losses, solve disagreements, change ownership and dissolve the partnership.
File income taxes as a general partnership
Your partnership itself doesn’t pay income taxes at the business level. Instead, the taxes “pass through” the partnership to you and the other general partners. Your partnership still has to file an annual information return (Form 1065) to report its income, deductions, gains and losses to the IRS.
Your partnership also must file a Schedule K-1 for each of the general partners to report how much of the business’s income each partner is responsible for. You and your partners need to report that income on your individual tax returns.
Top states for general partnerships
In general, Delaware and Nevada are considered to be the best states for businesses because their state laws offer tax advantages. However, since general partnerships don’t need to register with a state to form, state doesn’t matter as much as it does for an LLC or corporation.
Next steps
If a general partnership makes sense for your business, work with an attorney to create a partnership agreement between you and your partners, or create your own agreement using an online template.
If you’re still unsure about how to structure your business, read about your other options, including a sole proprietorship, limited liability partnership, limited liability company and a corporation. It’s also a good idea to talk to an attorney, accountant or a financial advisor to double check that the structure you choose is the best option for your business.
For more information about how to start your business, visit NerdWallet’s Small Business Guide.
Teddy Nykiel is a staff writer covering personal finance for NerdWallet. Follow her on Twitter @teddynykiel and on Google+.
Photos via iStock.
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