The Basics of Partnerships 101
How is a Partnership Created?
- A partnership is created when two or more persons enter business for profit.
- Unlike most business entities (Limited Liability Companies (LLC), Corporations, etc.), a written agreement is not required for a general partnership.
- Partnerships are generally governed under the Uniform Partnership Act (the UPA). Although each State will have varying rules governing partnerships, all states (excluding Louisiana) have adopted regulations peculiar to the UPA.
The “General Partnership”
- In a General Partnership (GP), all partners share in the management of the partnership and will share income made by the partnership and losses incurred by the partnership equally.
- All partnerships are presumed to be general partnerships unless an agreement is present to state otherwise (both an LP and LLP require an agreement).
- Should no partnership agreement be made between the parties, the State’s UPA regulations will be applicable; here, a partnership agreement will provide more elasticity.
- Partnerships are only taxed once rather than twice (“pass-through taxation).
- Does not require the recordkeeping that a corporation would require.
- All partners are personally liable with respect to the partnership; you can be held liable with respect to your partner’s negligence.
- Should one partner want to end that partnership, the partnership will end; a partnership requires two or more persons.
- When a partnership is terminated, the partnership must resolve any outstanding issues concerning the partnership, the partnership’s debt, and the partnership’s creditors. In addition, should anything remain, they must be allocated (equally) amongst the partners.
- “Buy-Sell Agreements to Avoid Dissolution
- Should a partner want to leave the partnership, a buy-sell agreement can be made to allow the remaining partner to purchase the leaving partner’s interest, and the partnership will continue.
- A partnership agreement to extend longer than a year is required to be in writing.
- Special Note on “Joint Ventures”
- A joint venture is a “general partnership” that will continue and remain valid until a contemplated event ends or at a certain time.
- Partnership Agreement Requirements:
- The name of the partnership and the partners
- A description of the business the partnership will conduct
- What each partner will provide as their “capital contribution.”
- Each partner’s obligations, responsibilities, and/or any restrictions or limitations placed on the partners.
- How income and losses will be divided amongst partners
- How partners are added and the manner/process regarding how partners leave
- How a partnership will “dissolve;” steps in the dissolution proceeds
The “Limited Partnership.”
- Unlike a general partnership, a Limited Partnership (LP) maintains two “classes” of partners: “general partners” and “limited partners.”
- The LP is a hybrid between the GP and the LLP in that a partner’s “personal” liability will be limited; however, all LPs must contain at least one general partner in addition to at least one limited partner.
- A limited partner cannot be involved in LPs day-to-day operations; a general partner is required to manage the partnership. Should a limited partner take on management, he will immediately be deemed a general partner and can become liable with respect to the partnership’s obligations and/or debt.
- General partners still have unlimited liability and are required to manage the partnership, like a partner would in a GP.
- Partners in an LP can only be held legally responsible with respect to their individual contribution. (Ex. Partner A and Partner B are partners in Taco Stand, LP. Partner A contributed $75,000 and Partner B contributed $5,000. Taco Stand, LP is bankrupt. Partner B cannot not be held liable with respect to any outstanding debts or obligations that exceed Partner’s $5,000 initial contribution).
- An LP might be considered when a general partner is looking to raise capital; an LP can invest without having to contemplate management (and allowing the general partner to retain control); based on the principle that some people (a chef, for example) maintain a unique and profitable skillset but have no ability to raise the initial capital to start a business, and those individuals skilled in raising capital don’t necessarily retain the skills to manage a business.
- “Pass-through” taxation.
The “Limited Liability Partnership”
- All partners can maintain limited liability, unlike an LLP.
- Unlike a GP and an LP, an LLP requires a written agreement between partners.
- An LLP is deemed a “legal person” and can engage in the activity that a person would: purchase property, lease property, retain employees, and execute contracts.
- Can come with legal reporting requirements.
- An LP can be explained as a cross between a partnership and corporation.
- Not all states permit LLPs (approximately 40 permit LLPs).
- An LLP is a beneficial business plan in that it spreads the risk level amongst partners, exploits individual skills and expertise, and establishes a clear labor division.
- Considered superior to a corporation or LLC due to pass-through taxation.