A general partnership is a business enterprise entered into by two or more persons who do not form a corporation or any other type of business entity to operate the business. If two or more individuals start a business together with the understanding that each will share in the profits of the enterprise, they are considered a general partnership even if they didn't specifically intend to start a general partnership. For example, if two sisters start a mail order business over the kitchen table and agree to share the profits, they are usually considered a general partnership if they don't form some other kind of business entity such as a corporation. Both very large and very small businesses can operate as general partnerships.
A joint venture is very similar to a general partnership except that it is usually formed either for a specific, limited purpose or for a limited period of time. For example, technology companies often form joint ventures to fund research and development of a particular item useful for their respective businesses (such as a specialized computer chip) when development might be too expensive for either company to fund alone.
Like the sole proprietorship, in most states, general partnerships are not required to file any certificates or other organizational documents with local, county, or state authorities; but they usually must file a
"fictitious name" certificate. Statutes in the state where the partnership is formed typically govern the rights and duties of the partners. These rights and duties may also be governed by a partnership agreement if the partners choose to have one prepared.
Advantages
- The arrangement of duties and benefits are flexible. Members of the partnership can structure the partnership according to their agreement. In comparison, in a corporation, allocation of profit and loss is proportional to the percentage of stock held by each stockholder. For example, in a corporation, the general rule is that if each stockholder owns 50% of the stock, each is entitled to 50% of the dividends. In a partnership, distributions of profits, losses and capital gains need not be directly proportional to the percentage interests held by the partners. Because of this flexibility, individual partners can be rewarded for taking special economic risks or for services provided to the partnership. One partner may agree to contribute most of the equipment used to start the business enterprise and to run it on a daily basis. In return, the partners may agree that this partner gets, say, 90% of the profits of the business. Under certain circumstances, however, the Internal Revenue Service will disregard disproportionate allocations.
- A partnership interest may be transferable because, unlike a sole proprietorship, a partner's interest in the partnership is a discrete asset. The partner can transfer the partnership interest to another person or to the partner's heirs or estate, when he dies or becomes disabled. Customarily, however, transfers of the partnership interest are restricted under the terms of the partnership agreement. These
"buy-sell" provisions usually give the partnership and the existing partners a
"right of first refusal" when a partner wants to transfer his interest in the partnership, even if the transfer is to a member of the partner's immediate family. One important purpose of these provisions is to prevent existing partners from having individuals (either known or unknown to them) become their partners. Transfers are also restricted to prevent unfavorable tax consequences that may occur if more than a certain percentage of partnership interests is sold within a certain period.
- General partnerships are more attractive to lenders because the lender will look to the aggregate net worth of all the partners in making a decision to extend credit.
Disadvantages
- Each partner in a partnership has liability for the obligations of the partnership. Each partner is, at a minimum, liable for at least his
"pro rata share." Under some circumstances each partner may be liable for the entire amount of all partnership debts and other obligations. Therefore, if the partnership becomes bankrupt or insolvent, one partner with greater assets may be required to satisfy the liabilities of the other partners even if they exceed what would ordinarily be considered that partner's pro rata share of those liabilities.
- Under the partnership statutes of most states, partnerships usually terminate upon the death or withdrawal of any partner unless the partners agree to continue the partnership. The partners may include a continuation provision in the partnership agreement or, in the event of a death or withdrawal, the remaining partners may agree to continue the partnership. Usually, the agreement to continue must be made within a specified period of time. However, if there is only one partner left, the partnership will be dissolved unless an additional partner (or partners) is admitted to the partnership within a specified period.
- Unlike the sole proprietor, general partners do not have the right to act alone in making partnership decisions. However, partnership agreements often give designated partners the authority to make specific kinds of agreements.
- General partnerships are limited in their ability to obtain financing that is other than
"debt financing." Unlike sole proprietorships, partnerships can raise capital by selling equity interests in the partnership. As a practical matter, however, the sale of such interests on a large scale is very difficult because of the prospect of potential personal liability and the usually limited market for resale of the interest.
Tax Treatment of General Partnerships
One of the advantages of a general partnership is that, like a sole proprietorship, the business is not taxed. Rather, income, losses, and gains are passed through to the general partners in accordance with the allocations provided in the partnership agreement. If there is no partnership agreement, income, losses, and gains will be allocated in proportion to the partnership interests of each partner. A particular advantage to this form of business is that the partners can agree among themselves as to how income, losses, and gains are divided among the partners. The partners then report the amount allocated on their own income tax returns and pay tax accordingly. However, there are some limits on the ability of partners to provide for disproportionate allocations.