PARTNERSHIP IN BUSINESS

16 Aug PARTNERSHIP IN BUSINESS

A partnership is the relationship existing between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business.

A partnership must file an annual information return to report the income, deductions, gains, losses, etc., from its operations, but it does not pay income tax. Instead, it “passes through” any profits or losses to its partners. Each partner includes his or her share of the partnership’s income or loss on his or her tax return.

If your business will be owned and operated by several individuals, you’ll want to take a look at structuring your business as a partnership. Partnerships come in two varieties: general partnerships and limited partnerships.

In a general partnership, the partners manage the company and assume responsibility for the partnership’s debts and other obligations.

A limited partnership has both general and limited partners. The general partners own and operate the business and assume liability for the partnership, while the limited partners serve as investors only; they have no control over the company and are not subject to the same liabilities as the general partners.

Unless you expect to have many passive investors, limited partnerships are generally not the best choice for a new business because of all the required filings and administrative complexities. If you have two or more partners who want to be actively involved, a general partnership would be much easier to form.

One of the major advantages of a partnership is the tax treatment it enjoys. A partnership does not pay tax on its income but “passes through” any profits or losses to the individual partners. At tax time, the partnership must file a tax return that reports its income and loss to the IRS. In addition, each partner reports his or her share of income and loss.

Personal liability is a major concern if you use a general partnership to structure your business. Like sole proprietors, general partners are personally liable for the partnership’s obligations and debts. Each general partner can act on behalf of the partnership, take out loans and make decisions that will affect and be binding on all the partners (if the partnership agreement permits). Keep in mind that partnerships are also more expensive to establish than sole proprietorships because they require more legal and accounting services.

Partnerships are relatively easy to establish; however time should be invested in developing the partnership agreement. In a partnership agreement, the following arrangements, among others, should be spelled out:

1. How the business will be financed.
2. Who will do what work.
3. What happens if a partner dies.
4. What happens if one or both partners want to dissolve the partnership.

It is strongly recommended that an impartial attorney be contacted to write the partnership agreement. Here’s how to find the right attorney.

 

Why Form a Partnership?

Once you have an idea for a company, whether this means selling a product or a service, understand the consequences of opting to become a partnership. As a business partner, you need to be prepared to devote time, use business methods, and get set up properly so you can make more money, minimize taxes, and generally avoid potential problems. Here are the pros and cons of forming a business partnership:

 

 

Business Partnership Advantages

• Partnerships are relatively easy to establish.
• With more than one owner, the ability to raise funds may be increased, both because two or more partners may be able to contribute more funds and because their borrowing capacity may be greater.
• Prospective employees may be attracted to the business if given the incentive to become a partner.
• A partnership may benefit from the combination of complementary skills of two or more people. There is a wider pool of knowledge, skills and contacts.
• Partnerships can be cost-effective as each partner specializes in certain aspects of their business.
• Partnerships provide moral support and will allow for more creative brainstorming.

 

Business Partnership Disadvantages

• Business partners are jointly and individually liable for the actions of the other partners.
• Profits must be shared with others. You have to decide on how you value each other’s time and skills. What happens if one partner can put in less time due to personal circumstances?
• Since decisions are shared, disagreements can occur. A partnership is for the long term, and expectations and situations can change, which can lead to dramatic and traumatic split ups.
• The partnership may have a limited life; it may end upon the withdrawal or death of a partner.
• A partnership usually has limitations that keep it from becoming a large business.
• You have to consult your partner and negotiate more as you cannot make decisions by yourself. You therefore need to be more flexible.
• A major disadvantage of a partnership is unlimited liability. General partners are liable without limit for all debts contracted and errors made by the partnership. For example, if you own only 1 percent of the partnership and the business fails, you will be called upon to pay 1 percent of the bills and the other partners will be assessed their 99 percent. However, if your partners cannot pay, you may be called upon to pay all the debts even if you must sell off all your possessions to do so. This makes partnerships too risky for most situations. The answer would be a different business structure.

 

If you Decide on a Business Partnership…

…you should create a “business prenup” that will protect a business if someone leaves.

This “business prenup” should spell out what will happen to your company if a co-owner:

• wants out of the business
• wants to retire
• goes through personal bankruptcy
• wants to sell his shares to someone else
• goes through a divorce
• passes away

 

You have two choices: you can have a business attorney write up your partnership agreement or you can do it yourself. If you decide to do it yourself, a good choice is “Business Buyout Agreements”, which walks you through the creation of a legal contract — a sort of “premarital agreement” for your business — that protects everyone’s interests. This document will help ensure a smooth transition following someone’s departure.