35 Partnerships
Saylor Academy
Let’s assume that after her first summer running Lily’s Landscaping, Lily decides that it’s time to take her business to the next level. She has gathered a lot of expertise in running the operations in her business, from placing orders with suppliers to scheduling workers for client projects. She realizes, however, that she’s not very good at marketing or accounting, and that if her business is to grow, she needs to bring someone on board who can create a strong brand and strategy for growth, as well as keep good records of her accounts so that she can plan for the future. Fortunately, her good friend Adam is a double major in accounting and marketing, and after a series of discussions, Adam and Lily decide to run Lily’s Landscaping together.
General Partnership
Lily and Adam have formed a general partnership. The moment they agreed to run Lily’s Landscaping together, and to share in the profits and losses of the business together, the partnership was formed. Although they formed their partnership verbally, most general partnerships are formed formally, with partners writing down their agreement in a special type of contract known as the articles of partnership. The articles can set forth anything the partners wish to include about how the partnership will be run. Normally, all general partners have an equal voice in management, but as a creation of contract, the partners can modify this if they wish. As in a sole proprietorship, there is no state involvement in creating a general partnership because there is no separation from the business and the partners—they are legally the same.
Properties
General partnerships are dissolved as easily as they are formed. Since the central feature of a general partnership is an agreement to share profits and losses, once that agreement ends, the general partnership ends with it. In a general partnership with more than two persons, the remaining partners can reconstitute the partnership if they wish, without the old partner. A common issue that arises in this situation is how to value the withdrawing partner’s share of the business. Articles of partnership therefore typically include a buy/sell agreement, setting forth the agreement of the partners on how to account for a withdrawing partner’s share, which the remaining partners then agree to pay to the withdrawing partner (or the spouse or heir if the partner dies).
A general partnership is taxed just like a sole proprietorship. The partnership is considered a disregarded entity for tax purposes, so income “flows through” the business to the partners, who then pay ordinary income tax on the business income. The partnership may file an information return, reporting total income and losses for the partnership, and how those profits and losses are allocated among the general partners. As is the case for sole proprietors, tax planning opportunities are limited for general partners.
General partnerships are also similar to sole proprietorships in unlimited liability. Every partner in the partnership is jointly and severally liable for the partnership’s debts and obligations. This is a very unattractive feature of general partnerships. One partner may be completely innocent of any wrongdoing and still be liable for another partner’s malpractice or bad acts.
Limited Partnerships
Let’s assume that the general partnership formed by Lily and Adam flourishes and becomes profitable. To grow the landscaping business, they want to bring in Lily’s wealthy uncle as a partner. The uncle, however, is worried about maintaining limited liability. In most states, they can form a limited partnership. A limited partnership has both general partners and limited partners. In this case, Lily and Adam will remain as general partners in the business, but the uncle can become a limited partner and enjoy limited liability. As a limited partner, the most he can lose is the amount of his investment into the business, nothing more. Limited partnerships have to be formed in compliance with state law, and limited partners are generally prohibited from participating in day-to-day management of the business.
Advantages and Disadvantages of Partnerships
| Factors | Consideration |
| Start-up | Fairly easy and cheap to form, though legal assistance is often helpful |
| Control | Partners must share decision making |
| Benefactors | Partners share profits |
| Taxation | Partners pay personal income taxes on their share of profits; the partnership doesn’t pay any special taxes |
| Capability | Can bring together a diverse group of talented individuals who share responsibility for running the business |
| Sustainability | Partners can agree legally to allow the partnership to survive if one or more partners die |
| Financing | The business can draw on the financial resources of a number of individuals |
| Liability | Partners are subject to unlimited liability; each partner is personally liable not only for his or her own actions but also for the actions of all the partners. The law also permits a limited partnership, which has two types of partners: a single general partner who runs the business and is responsible for its liabilities, and any number of limited partners who have limited involvement in the business and whose losses are limited to the amount of their investment. |
The Partnership Agreement
Partnerships are susceptible to conflicts and disputes since they require decision-maker to occur across all partners. The impact of disputes can be lessened if the partners have executed a well-planned partnership agreement that specifies everyone’s rights and responsibilities. The agreement might provide such details as the following:
- Amount of cash and other contributions to be made by each partner
- Division of partnership income (or loss)
- Partner responsibilities—who does what
- Conditions under which a partner can sell an interest in the company
- Conditions for dissolving the partnership
- Conditions for settling disputes
