A business partnership is an arrangement between two or more people. Partners own the business and work together to offer goods or services to their clients. They share business profits and losses. They also pool together their resources, such as money, property, and skills.
Sole proprietors can turn their businesses into partnerships. Partners also can form a limited liability company (LLC). Partnerships offer many benefits, whether you’re a consultant, freelancer, skilled trade worker, or other professional. To make the most informed decisions, it’s important to understand the pros and cons of a business partnership before engaging in one. Explore our guide below to see if forming a partnership is the right choice for you.
What Are the Types of Business Partnerships?
A partnership is the least expensive and simplest business structure to form. People who decide to go into business together can choose from four types of partnerships: a general partnership, limited partnership, limited liability partnership, or LLC.
Although each business partnership structure is similar, they have key differences. Here’s a quick look at the partnerships, including how they work and how they are formed.
A general partnership (GP) is when two or more people agree to jointly own a business. They share all business assets, profits, and liabilities, including financial and legal liabilities. In a GP, each partner agrees to unlimited liability. This means partners can be sued or have personal assets seized to cover business debts and other liabilities. General partners are also required to file personal income tax returns that include any earnings from the business partnership.
People may choose general partnerships because they have a flexible business structure that allows the business owners to make decisions and control operations. For example, a father and son working in construction. They decide to form a partnership so they can be their own bosses and control which jobs they take and when.
General partnerships are also easier and less expensive to form. You usually don’t need to register a formal document with any government agency; however, it’s highly recommended that partners have a written partnership agreement. This document acts as a contract to outline operation rules and the responsibilities of each partner. The agreement will help to resolve future conflicts, too.
A limited partnership (LP) is a business of two or more people with one general partner and one or more limited partners. A general partner has unlimited liability, and they’re responsible for running the business. A limited partner has limited liability, profit limits, and less control over the business. Both partners pay personal income taxes on business profits, but only the general partner pays self-employment taxes, too.
People may choose to form an LP when others want to invest in their business and share profits but have a limited role in business operations. For example, an accountant and three siblings decide to form an accounting firm. The oldest sibling is the general partner, so they make most of the decisions and run the business as their full-time job. The three limited partners invest in the business with a chance to make a profit, but their personal assets aren’t at risk should the business fail.
To form a limited partnership, you’ll need to complete the appropriate forms for your state. You’ll need to file these documents, usually with the secretary of state’s office, and pay all applicable fees to be recognized as an LP. If you plan to operate in more than one state, you must check each state’s requirements.
Limited Liability Partnership
A limited liability partnership (LLP) offers limited liability to every owner to protect all partners’ personal assets and income. It’s a lower-risk partnership option in which one partner’s actions don’t affect another. Partners come together to share resources, such as their expertise, clientele, and office space. An LLP is a flow-through entity for tax purposes, meaning each partner claims business profits when filing personal tax returns.
An LLP is a flexible business structure that allows partners to come and go. Professional groups tend to form LLPs to lower the cost of doing business while increasing the potential for business growth. Small law firms and consulting groups are prime examples of limited liability partnerships.
For example, a group of consultants decides to break off from a larger firm to form an LLP. They take on junior partners to deal with the detail work so they can focus on new clients to grow the business. Junior partners aren’t owners of the company and have no claim on profits; instead, they’re paid a salary.
To form an LLP, you must register your partnership with the state where you plan to do or are doing business. Forms are usually filed with the secretary of state’s business division with applicable fees. Requirements and costs vary by state.
The U.S. Small Business Administration (SBA) recommends partnerships for:
- Multiple business owners
- Professional groups
- Groups wanting to test profitability
Limited Liability Company
A limited liability company (LLC) is a business structure where the owners aren’t personally responsible for business debt or liabilities. Many existing general partnerships choose to form an LLC for this added protection of personal assets. LLCs can still be taxed as partnerships, so you can avoid paying business taxes. Partners in an LLC are known as members, and they’re free to choose their percentage of ownership in the business.
Limited liability companies are formed at the state level, usually with the secretary of state’s office. You’ll need to file a Certificate of Formation or Articles of Organization to register in the state where you plan to operate. It’s also usually required that you appoint a registered agent, apply for an employer identification number (EIN), and create an Operating Agreement.
What are the Pros and Cons of Partnerships?
It’s important to consider these advantages and disadvantages before starting a new business venture. They can help you decide whether forming a partnership is right for you.
One of the best advantages of entering a partnership is that it gives you someone to rely on. Partners support one another and reach for the same goals. Everyone works together to make the business a success. Here are a few other business partnership pros to consider.
- Additional knowledge: Partners are valuable assets when starting a new business. They bring their own knowledge, experience, and skills to the group. For example, an older partner can bring more years of experience to help answer an ambitious younger partner’s questions. The more you know, the more likely you are to succeed.
- Decreased financial burden: One major step to starting a new business is finding the funds for startup costs. Having a business partner or multiple partners helps decrease the financial burden. You no longer have to foot the bill yourself; your partners lend monetary support so you can realize your dreams of business ownership. A partner who invests in your business can act as a full partner or take a more limited role.
- More help: Starting a new business can be overwhelming. There are so many things to decide and do before you’re officially up and running. A partner or partners can help with a variety of business tasks. There is relief in knowing that you don’t have to do everything alone. Dividing your to-do list helps make the process go faster and smoother.
- Less paperwork and fewer tax forms: Contracts, invoicing, bills — there’s a lot of paperwork to deal with when you own a small business. Partners help lighten the load of handling business paperwork and tax forms. Even though partners are taxed as individuals, partnerships must file an annual information form with the federal government. A partnership also has much less paperwork to handle than a more complex business, such as a corporation.
There are also some cons of a partnership to consider, which may outweigh the pros, depending on your situation. Also, you may not face some of these disadvantages until your business is past the initial startup phase.
- Sharing business decisions: If you’re used to being in total control, you may find it hard to enter into a business partnership. Partners often have to make decisions together, and you may not always agree. Since disagreements are bound to happen, you need to be sure you’re prepared to handle them. A formal Operating Agreement signed by all partners is a way to alleviate and solve issues. Partners sometimes end up parting ways and ending friendships over business decisions.
- Splitting the profits: If you’re a sole proprietor or a freelancer, you’re used to keeping hard-earned profits for yourself. Partners must split the profits as set forth in your partnership agreement, and you may find it hard. However, taking on partnerships may increase your profits in the long run. How profits are split depends on the type of partnership. It’s also usually based on a partner’s investment in the business.
- No separation from the business: In some partnerships, all partners are legally and financially responsible for the business. Personal liability means if your business is sued or in debt, your personal assets are at risk. Your personal property and money could be used to pay for business expenses. Partners with unlimited liability are at the greatest risk. If this is a concern, consider being a limited partner. Forming an LLP or LLC also offers greater protection of personal assets for business partners.
- Individual taxes: Partnerships and limited liability companies taxed as partnerships are known as flow-through entities. This means the business income passes through to its owners. Partners bear the burden of paying taxes on this income each year when they file their individual tax return with the IRS. General partners also need to file self-employment taxes. Sometimes, it’s more affordable to pay business taxes than individual taxes. Consult with a tax professional to understand your tax obligations.
Enter into a Business Partnership Wisely
It’s easy to get excited about a new business venture and partnership possibilities. It’s important to remember that entering into a business partnership should be done wisely. Look at your partnership options from every angle and get all the answers to your questions before proceeding. Seek expert advice from business and legal professionals to make sure you completely understand what you’re entering into.
At ZenBusiness, we work with trusted partners to help customers like you start, run, and grow their businesses. If you need help starting or growing your business partnership, contact ZenBusiness to discuss our expert business services. From filing registration paperwork to registered agent services, we’re here to support you every step of the way toward success.
Questions to Ask Yourself When Entering Into a Business Partnership
Do you work better alone or with others?
When answering this question, be honest with yourself. There’s a big difference between thinking you can work well with other people and knowing you can. If you’re someone who works better alone, a partnership may not be the best choice, and that’s completely OK. A sole proprietorship still allows you to be a small business owner.
Are you willing to be liable?
Depending on the partnership, you may have limited or unlimited liability. Consider carefully if you’re in a position to take on financial burdens and other liabilities as a partner. If you’re willing to be liable, seek professional financial advice to make sure you can do so.
Is my prospective business partner a good match?
Starting and running a business can be a stressful and tiring endeavor. A potential partner should be someone who complements you and your skill set. Keep in mind that personal relationships are much different than business relationships. It’s important that partners communicate well with each other. You need to be able to talk openly to solve problems and help the decision-making process go smoothly.