Partnership Rules FAQ

Many entrepreneurs and small business owners consider forming a business partnership. This happens when they want to join forces with another individual and can be an exciting step toward growing a new business, but it also brings many questions.

This FAQ guide aims to answer those questions. It covers everything from the basics of business partnerships to the more intricate details of business law.

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Frequently Asked Questions

• What is a partnership?
• What are the different types of partnerships?
• How is a partnership created?
• Are there rules on how partnerships are run?
• Do partnership agreements need to be in writing?
• What's my personal liability for the business obligations of the partnership?
• What's the difference between a partnership and forming a corporation?
• How do partnerships pay taxes?
• How do partnerships terminate?
• What are the advantages of forming a partnership?
• What are the disadvantages of forming a partnership?
• Get legal help with your partnership needs

What Is a Partnership?

A business partnership happens when two or more individuals decide to go into business together. The partners carry on as co-owners and share profits and losses. There can be a contribution of money, like a capital investment in the business project, by a partner. There can also be a contribution of services in return for a share of the profits. Business partners work cooperatively to achieve the goals of their small businesses.

Business partnerships are unlike sole proprietorships. In these business entities, one person is the business owner. In partnerships, several people share responsibilities. Business owners in partnerships have a say in the day-to-day operations. They might also contribute capital or services and share profits and losses. This is usually based on their business partnership agreement.

What Are the Different Types of Partnerships?

There are three types of partnerships: general partnerships, joint ventures, and limited partnerships. In a general partnership, general partners share in business operations. They also have personal liability. Joint ventures are the same as general partnerships except that the partnership only exists for a specified period of time. It can also be for a specific project.

Limited partnerships consist of partners who maintain an active role in the management of the business and those who just invest money and have a very limited role in management. These limited partners are essentially passive investors. Their liability is limited to their initial investment.

Then there's a limited liability partnership (LLP). In an LLP, partners have protection from personal liability. Each type of business entity has its pros and cons, and which one suits your business depends on your situation.

How Is a Partnership Created?

There are no formal requirements for a business relationship to become a general partnership. This means you don't have to have anything in writing for a partnership to form. The key factors are two or more people who are carrying on as co-owners and sharing profits. Even if you don't intend to be a partnership, if that's how you hold yourself out to the public, then your relationship will be deemed a partnership. All partners will be liable for the obligations of the partnership.

Limited liability partnerships do have a written requirement. It's a document that states that a limited partner has invested money into the partnership. This partner retains little or no control over the partnership's operations. In this way, limited partners are not liable for the partnership's debt obligations. The limited partner does not influence the partnership significantly.

Starting a partnership requires a few steps. New partners should choose a business name and check its availability with the secretary of state. They should also register the business and decide on its structure. Some states allow businesses to operate informally. 

Although there's no requirement for a written partnership agreement, often it's a very good idea to have such a document to prevent disagreements and give the partnership solid direction. Having a formal agreement can prevent legal issues in the future. It's crucial to understand state law and local business law when doing business as a partnership.

Are There Rules on How Partnerships Operate?

The only rule is that in the absence of a written agreement, partners don't draw a salary and instead share profits and losses equally. Partners have a duty of loyalty to the other partners and must not enrich themselves at the expense of the partnership. Partners also have a duty to provide financial accounting to the other partners.

For example, if you're in a partnership, you cannot make a deal to buy from a supplier at an inflated price with the understanding that you will receive a kickback from the supplier. It's a violation of your duty to the partnership, and your partners can demand an accounting from you about the deal. If you're found to have violated your duties, the partners can sue you for damages and strip you of your profits from the deal.

On the other hand, if you simply make a bad deal by signing a contract to pay a supplier an inflated price, the partnership must accept the deal. One of the potential drawbacks of a partnership is that the other partners are bound to contracts signed by each other on behalf of the partnership. Choosing partners you can trust and who are savvy is critical.

The Uniform Partnership Act provides some standard rules, but business partners usually outline their own rules in a business partnership agreement. This document determines day-to-day operations. It also discusses the responsibilities of each partner, how to resolve disputes, and outlines the procedures for making major business decisions. Every state has its take on the Uniform Partnership Act, so it's important to consult your state's regulations.

Do Partnership Agreements Need To Be In Writing?

No. It is not always required by state law that the partnership agreement be in writing. While partnerships are unique business relationships that don't require a written agreement, it's always wise to have a written partnership agreement.

This formal agreement ensures clarity on business operations. It also provides clarity on partner shares and other critical areas of the partnership. When issues arise, or new business conditions appear, a written agreement can help guide decisions and resolve disputes.

What's My Personal Liability for the Business Obligations of the Partnership?

Partners are personally liable for the business obligations of the partnership. This means that if the partnership can't afford to pay creditors or the business fails, the partners are individually responsible for paying for the debts, and creditors can go after personal assets such as bank accounts, cars, and even homes.

In general partnerships, partners have personal liability for the business's debts. This means creditors can go after a partner's personal assets. However, in an LLP, partners have limited personal liability. Still, each partner is liable for their actions. It's essential to understand the implications of the business structure you choose.

For example, if the partnership dissolves and there are still outstanding debts to suppliers or lenders, those creditors can sue you personally to pay for the debts. Debts of the partnership will expose your personal assets to liability unless you're a limited partner, in which case your liability caps at the money you've invested.

What's the Difference Between a Partnership and Forming a Corporation?

The major difference is that in a partnership, creditors can sue you personally to repay business debts. In partnerships, profits and losses pass directly to the partners. This affects their personal tax returns. Corporations, conversely, are separate legal entities. They need incorporation and pay taxes differently.

In the example above, if you had formed an LLC instead of a partnership, your personal assets would be safe from creditors of the business. In legal parlance, creditors cannot pierce the corporate veil. This means the formation of the corporate entity forms a protective shield around your personal assets. It's a major advantage of forming an LLC, but LLCs also need more paperwork and money to register, start up, and maintain.

How Do Partnerships Pay Taxes?

Taxes are paid through the personal income tax filings of individual partners. Partnerships don't pay taxes as a single entity. Instead, profits and losses pass to the partners. Each partner then reports their share on their personal tax returns. Partners pay taxes based on their income from the partnership and other sources.

As a partner, you have income through your share of the profits, or a loss if the partnership is losing money. You report this income on your personal taxes. The partnership itself reports profits and losses to the IRS in a special form. You pay the taxes on your portion.

How Do Partnerships End?

Partnerships can end for many reasons. For example, a partner's retirement, disagreements, or business failures can lead to termination. The partnership agreement outlines the process of ending the partnership. If there's no agreement, state laws will dictate the termination process.

If you don't want your partnership to end so easily, you can have a written agreement that outlines the process through which the partnership will dissolve. For example, the partnership can dissolve if a certain event happens, or it can provide a mechanism whereby the partnership can continue if the remaining partners agree to do so.

What Are the Advantages of Forming a Partnership?

Partnerships offer several benefits, including:

• Easy to establish with a simple setup process
• Flexibility in business operations
• Business owners share risks and rewards
• Entrepreneurs can pool resources and share responsibilities
• Partners can capitalize on different skill sets
• Raising funds may be easier with more owners
• Profits go right into partners' pockets, providing for easier tax reporting
• Employees want to work for the partnership if they have an opportunity to become a partner

What Are the Disadvantages of Forming a Partnership?

Partnerships come with challenges, too, including:

• Partners are individually liable for business debts
• Partners are subject to the actions of other partners
• The limited life of a partnership -- if one partner leaves, the partnership can end
• Shared decision-making means you do not have full control and can lead to disagreements within the partnership

Disputes can arise, especially if there's no written agreement. This is why it is so important to have a formal written partnership agreement. An attorney can help you create this critical document.

Get Legal Help With Your Partnership Needs

The type of business organization you form is a decision you must make on your own. However, an experienced business attorney will be able to guide you and your partners through the process. They can help find any potential trouble spots before they become actual problems. Attorneys can help you draft any legal documents or operating agreements needed.

Speak to an experienced business attorney about your partnership questions today.