A general partnership is the most basic form of a partnership. Found under common law, it is the definition of an association of people or an unincorporated company. It must be created by agreement, estoppel, and proof of existence. A minimum of two people is required. Under the structure of this business type, all partners have an equal share in the liability and responsibility of the business.
Under this structure, each partner is taxed on their personal income tax return instead of a business tax return. That means all business income must be included on the returns. Then partners can deduct losses from the business on their own returns.
Here are some of the key advantages and disadvantages of a general partnership to examine.
List of the Advantages of a General Partnership
1. Pass-through tax treatments are available with a general partnership.
There is no taxation of the actual business when operating within a general partnership. All income and loss are reported on the personal tax returns of each partner. That means partners get to take advantage of the pass-through taxation structure when the company is based in the United States. Any credits and deductions for which the business would qualify transfer over to the personal returns. That can limit the taxation liabilities of the income earned.
2. They are usually easier to form.
A general partnership is about as easy to form as a sole proprietorship. There are fewer formalities involved with their formation when compared to corporations or limited liability partnerships. A centralized management structure can be formed with a partnership, much like a corporation, or a decentralized structure can be implemented if preferred. The only primary document required is a partnership agreement which outlines the responsibilities of each partner to the business.
3. It is a default business entity.
Just like a single individual (or a married couple) automatically form a sole proprietorship when conducting business, a general partnership is treated in the same way. As long as the partners agree amongst themselves over the guidelines of the business, there is no legal requirement to draft the details of the business before beginning operations. Most states in the U.S. do not have any required maintenance activities either.
4. It allows multiple people to come together to start a company.
Multiple people from unique backgrounds can come together, pool their resources, and form a general partnership that can lead to profits. That means there can be more diversity within the leadership of a general partnership when compared to other business types. These experiences and skills can help to build an effective and profitable business venture in time that has real lasting power for the community.
5. There are no tax withholding requirements for partners.
A general partnership may have several people working together at once under the umbrella of the business. Partners, under U.S. law, are not responsible for withholding tax payments from one another. That further simplifies the filing process, even though an Employer Identification Number is often required for this type of business. Only when an employee is hired does the obligation to withhold taxes and send them into the government kick in.
6. The structure can be converted to other business types.
The liability issue for a general partnership is one of great concern. Unlike with a sole proprietorship, a general partner is only 50% responsible, at most, for liabilities incurred by the business. If there are 5 partners involved, then the liability percentage drops to 20%. Even then, however, there can be too much risk in this type of structure because there is no personal asset protection. For that reason, many general partnerships eventually form into an LLC to reduce the risks presented by the disadvantages of a partnership structure.
7. More than one person can be involved in fundraising efforts.
Unlike a sole proprietorship, the structure of a partnership allows for multiple people to be engaged in fundraising efforts for the company. Although fundraising can be difficult in this structure due to the personal liabilities involved, having more people active can create more chances for success. That leads to improved management techniques within the business, which allows the partnership to benefit from the created efficiencies.
8. There is an equal right to manage the business within a general partnership.
Anyone is who is part of the initial general partnership when a business is formed under this structure is given an equal right to manage the business. For that reason, large partnerships should develop an agreement which outlines each partner’s role within the company. The last thing you want, after all, is to have 5 people all trying to be the CEO while nothing else gets done.
9. Limited partnerships are possible in some region.
A limited partnership is permitted within the general partnership structure in some areas. Under this structure, there would be one general partner, then at least one limited partner. The general partner is responsible for the management of the business. A limited partner contributes assets to the business without a role in how the company is managed.
List of the Disadvantages of a General Partnership
1. Personal assets are at-risk within a general partnership.
Unlike other business structures, a general partnership does not act as an independent entity. That means the financial protections which partners have in a corporation structure are not found within this structure. A general partnership is more like a sole proprietorship instead. If there is an issue which affects the finances of the organization, then each partner faces a potential personal liability for costs that may be incurred.
2. General partners are deemed to be agents.
Every general partner that is part of the organization is deemed to be an agent of the partnership relationship. That means if one general partner is representing the company or carrying along with partnership business, then every other partner can be held out as partners when dealing with a third party. That also means that every partner in the structure is liable for the debts that are incurred by the other partners in the course of doing business.
3. It can be difficult to raise money in a general partnership.
Because each person within a general partnership has personal taxation liabilities, along with general debt liabilities, that fall somewhat outside of their direct control, investors are not a big fan of this type of business. That can make it difficult to find enough money to continue growing outside of the personal networks of the general partners. For that reason, many general partnerships tend to stay as a small business or eventually restructures itself into a corporation or LLC.
4. Liabilities in a general partnership are unlimited.
Any losses that are incurred by the business are inseparable. There is unlimited access to the personal assets of each partner when a creditor makes a claim. The liabilities are also unlimited, which could force some partners into bankruptcy to preserve some of what they own. Should that occur, the negative credit fallout from such an action could last 7-10 years.
5. Some partnerships can be terminated even though the business is successful.
The reason why a general partnership agreement should be in place is that the presence of all partners is necessary for the business to have life. If a partner should decide to leave the business for some reason, or happens to die unexpectedly, then the partnership is terminated without the presence of an agreement. That means the assets would be distributed to the partners and the business would need to restart.
6. Many general partnerships suffer from instability.
Many agreements are formed by verbal commitments and handshakes within the context of a general partnership. That occurs because most people who start a business together already know one another. When family or friends work together for the first time, there is an expectation of mutual morals and ethics. Should that change, these informal agreements, which may be legally binding, can lead to business instability over time. If no legal agreements are in place to settle a dispute, the chaos created can be even more profound.
7. There may be business taxes to pay from personal finances.
In Washington State, there is not a state income tax. There is a business and occupation tax which applies to all businesses. If your company earns enough revenue during a quarter, then you’ll be asked to pay the state taxes as part of your agreement to do business. An assumed business name registration is also usually required, plus certain licenses and certifications. Depending upon the type of business formed, a surety bond may also be required. That can put the cost of starting a business upwards of $2,000 for some general partnerships in the state.
8. You must be licensed before doing business in many states.
Some states allow a default business organization structure to conduct business immediately. If there are business license requirements in place, however, the general partnership must wait for receipt of the business license before serving their first customer. Some business types, like a restaurant, may require health inspections and other documentation before being allowed to be open for business.
9. General partnerships are exposed to the self-employment tax.
Partners are classified as self-employed individuals when they are performing services for the business. Net earnings include the distributive share of income (or loss) that comes from the business. That means general partners are liable for the self-employment tax in the United States. In 2018, the self-employment tax is 15.3%, with 2.9% going to the Medicare tax and the remainder going to Social Security.
10. Guaranteed payments are considered net earnings.
In the United States, if a general partner receives a guaranteed payment from the business or partnership agreement, then that income counts as net earnings. Even if the business takes a loss, the net earnings could create a tax responsibility for some partners. All net earnings are also subject to the self-employment tax. Until income levels reach $128,400 in 2018, the full amount applies. Above that level, only the Medicare tax applies.
11. Disputes can limit the growth of the business.
Partners don’t get into business with one another expecting to encounter disputes around every corner. As time goes on, different partners may develop conflicting visions for the company. If a dispute is allowed to exist for a prolonged time period, it can hamper the growth of the business. With the joint and several liabilities permitted within this business structure, some partners may decide to leave the business to cancel the contract, if possible, to avoid potential repercussions.
12. Most of the time, partners are not allowed to transfer their interest in the business.
Unless specifically outlined in a written partnership agreement, a partner is not allowed to transfer or divest themselves of their interest in the business on their own. If no specific regulations are in place for a transfer to take place, then some states may permit a unanimous vote of the other partners. That places further pressure on the initial founding of the business, as a single partner may be able to force the issue by filing an intent to abandon the partnership instead.
These general partnership advantages and disadvantages show that this type of business is cheap and easy to form. With a solid partnership agreement in place, each partner can know what is expected of them, which allows the business to run smoothly. As with any business venture, there are risks involved, including a mutual risk of personal liability, should debts be incurred by the company.