What Is a General Partnership? (+ How To Form One) - DeanSwanepoel.com

What Is a General Partnership? (+ How To Form One)

A small business is often thought of as a solo operation—one entrepreneur with a dream, working night and day to bring it to fruition. 

But sometimes, two heads are better than one. When you’re looking to make your small business a group effort, a general partnership may be the easiest and most straightforward format for you to pursue: You and your partners don’t need to file any paperwork with state or federal governments—all you need is a verbal agreement to team up.

What is a general partnership (GP)?

A general partnership is a business entity in which two or more partners agree to share in a company’s profits, losses, and assets. By default, partners share these things equally—unless their partnership agreement stipulates otherwise. 

Three key elements of a general partnership

  • It’s the default structure for partnerships. Just like sole proprietorship is the default business structure for individual business owners, a general partnership is the default for multi-owner businesses. 
  • You and your partners are personally liable. Similar to sole proprietors, partners in a general partnership take on personal responsibility for the business. That means equal liability for debts or legal action. Partners can adjust the split of both profits and liabilities in their partnership agreement, but an equal split is the default.
  • You’re taxed only one time. General partnerships are pass-through entities, meaning partners pay income taxes on profits at the personal level. Compare this with corporations, where the business and its owners pay taxes on profits. The IRS considers distributions self-employment income, so you’ll have to pay taxes for Social Security and Medicare. 

Partner responsibilities of a partnership 

A duty of loyalty and care

Partners in a business partnership owe each other a fiduciary duty of loyalty and care. This means that partners must act in the partnership's best interests and not in their own self-interest. Partners must not take advantage of their position or use the partnership’s assets for personal gain.

A duty of good faith and fair dealing

Partners must also act in good faith and deal fairly with each other. This means partners cannot secretly engage in activities that harm the partnership. For example, a partner cannot secretly buy property the partnership was planning to purchase.

The duty of disclosure

Partners have a duty to disclose material information to the other partners. This duty exists even if the information is not favorable to the partnership. For example, if a partner knows of a potential problem with a supplier, he or she must disclose this information to the other partners.

A duty of obedience

Partners must obey the partnership agreement and any lawful decisions made by the partnership. If there is no partnership agreement, partners must obey any decisions made by most partners.

A duty of account

Partners must keep accurate records of the partnership’s finances and transactions. Partners are entitled to inspect the partnership’s books and records at any time.

General partnerships: advantages and disadvantages

At its core, forming and running a general partnership is a group venture. As with all group ventures, it presents its fair share of pros (like easy and quick formation) and cons (like no liability protection).

Advantages of forming and running a general partnership

It’s hard to go it alone. A general partnership allows partners to spread the load among themselves. While other entity types are available to a business with multiple owners, the general partnership structure is especially lightweight. 

Easy and inexpensive to form 

Creating a general partnership is very simple: all that’s required is a verbal agreement among the partners. (Though a written agreement is always the safest bet.) Since there’s no startup cost, forming a general partnership is less expensive than forming a limited liability partnership, which is subject to more stringent regulation by tax authorities and usually requires certification fees.

Partners should have a written partnership agreement, because it will help them resolve any disagreements that may come up and determine in advance how the partnership will be run. If the partners don’t have a partnership agreement, they will be subject to the state’s default rules for running the partnership.

Tax benefits

General partnerships enjoy “pass-through taxation,” meaning taxes on the general partnership’s profits and losses are passed through the business and directly on to the owners, who then are liable for them on their personal income tax returns. 

This means profits generated by the general partnership are taxed only once. Compare this to other business structures, like C corporations, which are taxed twice—the business files taxes on profits, and owners personally pay taxes on their earnings. 

General partnerships are a few entity types that enjoy pass-through tax status; others include limited liability companies (LLCs) and sole proprietorships.

Easy to dissolve

If you and your partner(s) no longer wish to be in business together, dissolving the general partnership is almost as simple as forming one. 

To dissolve a general partnership, you must:

  1. Notify tax authorities both at the federal and state levels
  2. Notify all possible creditors of the business that the partnership has dissolved and that you will not be individually responsible for additional liabilities

Though not required, for the sake of tidy record-keeping, your accountant or attorney may recommend that the partnership submit a dissolution and liquidation form to the secretary of state’s office in which you conduct business

Disadvantages of forming and running a general partnership

Although forming your small business as a general partnership has some key advantages, it also has drawbacks: personal liability for the partners. 

Personal assets at risk

General partnerships are not considered legal entities separate from ownership. That means partners are personally responsible for any legal liabilities in connection with the general partnership—and they may need to forfeit their personal assets to cover damages or unpaid business debts.

Unlimited liability

Because partners in a general partnership are personally responsible for all debts and obligations of the business, they are also liable for each other’s actions. If a partner causes physical or financial injury to another party in the course of business, the whole general partnership may be liable in court for the damages. 

Other types of partnerships offer stronger liability protections, such as limited partnerships and LLPs.

Inability to fundraise

In general partnerships, all owners assume unlimited liability—which makes it hard to fundraise. To fundraise by selling partial ownership to a partner whose liability is limited, the partnership would have to convert to a limited partnership. 

Forming an entity for you and your business partner

When considering how to structure a new general partnership, here are some questions for you and your business partners to work through via research and potential consultation with an attorney:

  • How many partners do you plan to include?
  • Will you form your partnership by verbal or written agreement?
  • Are you and your partners prepared to be equally and personally liable for the business?
  • Are you and your partners willing to share equally in the business’ profits? If not, what modifications are you collectively willing to make to the partnership agreement?
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