Are You Forming a Partnership?
Are you considering forming a partnership for your business? A partnership is an association of two or more co-owners who develop and run a business for profit.
You may be asking yourself, “How are Partnerships Formed?” In this article, we’ll answer that question and several others.
Owning your own business requires having knowledge in many different areas. Depending on the type of business you own, you may need to have a thorough understanding of how to market your business, how to keep detailed records regarding income, expenses and client lists, and how to manage day-to-day business activities.
Perhaps more importantly, you’ll need to know how to legally structure your business in a way that is most profitable for all partners involved.
How to Determine if a Partnership is Right for Your Business
Some facts to consider when deciding whether a partnership is the appropriate business structure for your business are:
- Can the business be easily and properly managed by just a few people?
- Is there an existing sole proprietorship that is simply being expanded by adding additional partners?
If either of these factors are present, a partnership entity may make sense.
As with most business agreements, if you are starting (or modifying) your business and considering forming a partnership to include two or more owners, there are issues you ’will need to evaluate to determine whether a partnership is the best choice for your business structure.
Although a partnership is often less complicated to maintain compared to a corporation, there are other factors to consider before deciding which structure may be best for your business.
What is a Partnership, and are there Various Types of Partnerships?
As mentioned above, a partnership is a business entity or structure where two or more owners are involved.
Generally, partnerships are formed when a business is growing but does not require the complexity and associated flexibilities provided by a corporation.
There are four basic types of partnerships available to business owners who are operating their business as a joint venture.
Each partnership type allows for different levels of personal and financial responsibilities for the various partners involved in the business. The following is a basic overview of the partnerships recognized by Arizona.
A General Partnership (GP) is typically formed when 2 or more people agree to work together to operate a business equally.
An example would be two people who are starting a professional home cleaning business and expect to share the workload and financial responsibilities as an equal team.
In a General Partnership, each partner is responsible for business expenses and liabilities, and they share the management duties of running the business.
A general written agreement, known as a “partnership agreement”, drafted by a qualified business lawyer is often sufficient for a partnership.
A Limited Partnership (LP) is often created when one or more of the owners will have more responsibility for handling the day-to-day responsibilities, and another partner (or partners) wishes to have limited involvement in the business.
An example would be if two people want to start a business and share in the financial and workload responsibilities equally, while a third partner is a financial investor only.
A Limited Partnership can assure that a partner’s potential for business loss is capped at the extent of their investment, and can establish that they are typically not involved in the day-to-day operation of the business.
As with a general partnership, a written and signed partnership agreement is strongly suggested when forming a limited partnership as it would contain details regarding each partner’s physical and financial responsibilities to the business.
Limited Liability Partnership
A Limited Liability Partnership (LLP) is similar to a general partnership in that all parties general share financial and physical responsibilities for operating the business.
However, with this type of structure, partners generally are absolved of responsibility if another partner acts negligently when acting on behalf of the business, or otherwise incurs liability when operating the business.
Again, a partnership agreement is required with this type of a business structure to protect each partner from personal liability for the actions of another partner or the business.
Limited Liability Limited Partnership
A Limited Liability Limited Partnership (LLLP) is, essentially, a combination of a Limited Partnership and a Limited Liability Partnership. One or more owners may have more day-to-day responsibility and/or financial investment than others, and a negligent act by one partner should not, result in liability to other partners.
Because of the complex nature of this type of business structure, a partnership agreement that is drafted by an experienced business lawyer is strongly recommended.
Partnerships and Tax Liability
Although partnerships must file a separate tax return to the IRS regarding the income, expenses, gains, and losses of the business, the liability for any taxes owed flows, to the individuals listed on the partnership agreement and not to the partnership entity.
It should be noted, however, that in a general partnership if one partner fails to hold up their end of the financial responsibilities such as debts or taxes owed, the remaining partner may be responsible for all financial obligations.
Because different types of partnerships can allow for partners to have varying levels of responsibility regarding their contributions and financial liability a partnership agreement written by a qualified business law attorney is crucial for the legal protection of each partner involved.
Partnerships and Management Structure Requirements
Whereas corporations are required by law to create boards of directors and hold formal meetings, partnerships are allowed to be managed solely by the partners and no formal meetings are required.
This can make management of business partnerships easier, however, if a business is growing at a rapid pace, a transfer of the business entity from a partnership to a corporation may be warranted in order to help owners better manage their workload with the accountability and assistance of qualified board members.
What Else Should I Know About Partnerships?
There are other ways in which partnerships differ from incorporated businesses. Here are some of the facts regarding partnerships you may want to consider as you decide which type of legal entity may be best for your business.
1. Unlike with corporations or LLCs, partnerships are not considered separate legal entities. The partners are fully responsible for any financial or legal liabilities This is why partnership agreements that are crucial to a well-run partnership.
2. While in general partnerships all partners are equally responsible for debts incurred by the business, limited partnerships can allow for specified partners to relinquish business management responsibilities for the sake of limited responsibility regarding the company’s debts.
3. All partnerships must comply with their specific state’s registration requirements. For more information on Arizona’s business partnership requirements, you can contact our office.
4. Partnerships may be able to be filed under a business name created by the partners.
Partnerships are easier to implement and manage than corporations or even LLCs, but there are still important decisions that partners need to make before creating the agreement that will outline the formation of the partnership and establish each partner’s roles and responsibilities.
How do I Know if a Partnership is the Right Choice for My Business?
A partnership can be a good choice for a business that is smaller and intends to stay that way for a few years but is run by more than one person.
A partnership status may not be a good fit for a business that is growing quickly and may soon need additional accountability such as a board of directors.
In general, while a partnership does allow for more flexibility in establishing business rules and regulations, a corporation does help limit the owners’ personal responsibility for business debts and due taxes incurred by the business.
As mentioned above, there are many reasons why establishing a business as a partnership could be beneficial for you and your business partners.
With so many different choices for business entities, having a helping hand to walk you through the various avenues of business designation can help save you a lot of work, time and money as you decide how to establish your business’s legal structure.
If you are interested in learning more about the legal process regarding the formation of a partnership for your business, contact our office today to speak with one of our qualified business law attorneys.