Simply put, whenever two or more people own a business together and share in its profits and losses, they are said to have a partnership. However, it is always a good idea to get a partnership agreement in writing, so as to make sure everyone has the same expectations. A written agreement can save a lot of headaches later on, if or when the partners have disputes or decide to part ways.
The first step in creating a partnership agreement is to decide what type of partnership it should be. The most common forms are general partnerships, limited partnerships and limited liability partnerships.
A general partnership is a legally simple structure in which two or more people own the business and share equal rights to it, sharing equally in profit and loss. For tax purposes, a general partnership is taxed as a “pass-through” entity, meaning profits pass through to the partners, where they are taxed as part of their personal income at a lower rate. The rewards to this type of partnership can be great, but the requirement that all partners share in the loss means that the partners are personally liable for the company’s debts. This can be a big problem.
A limited partnership is meant to shield some, but not all, of the partners from personal liability. One partner must remain personal liable, but the others will only share liability to the extent of their investments in the business. Leadership is different under this type of arrangement. A partner who remains personally liable is known as the general partner, and retains the right to control the company. The limited partners are not involved in management.
A limited liability partnership, or LLP, provides more liability protection for the partners while also allowing them to take advantage of “pass-through” status for tax purposes. In an LLP, the partners are not personally liable for the debts of the business, nor can they be held liable for wrongful acts by a fellow partner.
Choosing the right legal format for your new business is important. Speak to a business attorney about your legal options.