Entrepreneur: Partnership – Entrepreneur Small Business Encyclopedia

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 doesn’t 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 (Form
1065) that reports its income and loss to the IRS. In addition,
each partner reports his or her share of income and loss on
Schedule K-1 of Form 1065.

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.

If you decide to organize your business as a partnership, be
sure you draft a partnership agreement that details how business
decisions are made, how disputes are resolved and how to handle a
buyout. You’ll be glad you have this agreement if for some reason
you run into difficulties with one of the partners or if someone
wants out of the arrangement.

The agreement should address the purpose of the business and the
authority and responsibility of each partner. It’s a good idea to
consult an attorney experienced with small businesses for help in
drafting the agreement. Here are some other issues you’ll want the
agreement to address:

• How will the ownership interest be shared?
  It’s not necessary, for example, for two owners to equally share
  ownership and authority. However, if you decide to do it, make sure
  the proportion is stated clearly in the agreement.
• How will decisions be made? It’s a good
  idea to establish voting rights in case a major disagreement
  arises. When just two partners own the business 50-50, there’s the
  possibility of a deadlock. To avoid this, some businesses provide
  in advance for a third partner, a trusted associate who may own
  only 1 percent of the business but whose vote can break a tie.
• When one partner withdraws, how will the
  purchase price be determined? One possibility is to agree on a
  neutral third party, such as your banker or accountant, to find an
  appraiser to determine the price of the partnership interest.
• If a partner withdraws from the partnership,
  when will the money be paid? Depending on the partnership
  agreement, you can agree that the money be paid over three, five or
  10 years, with interest. You don’t want to be hit with a cash-flow
  crisis if the entire price has to be paid on the spot on one lump
  sum.