PARTNERSHIP

Photo by: Yuri Arcurs

In the words of the Uniform Partnership Act, a partnership is “an
association of two or more persons to carry on as Co-owners of a business
for profit.” The essential characteristics of this business form,
then, are the collaboration of two or more owners, the conduct of business
for profit (a nonprofit cannot be designated as a partnership), and the
sharing of profits, losses, and assets by the joint owners. A partnership
is not a corporate or separate entity; rather it is viewed as an extension
of its owners for legal and tax purposes, although a partnership may own
property as a legal entity. While a partnership may be founded on a simple
agreement, even a handshake between owners, a well-crafted and carefully
worded partnership agreement is the best way to begin the business. In the
absence of such an agreement, the Uniform Partnership Act, a set of laws
pertaining to partnerships that has been adopted by most states, govern
the business.

There are two types of partnerships:

GENERAL PARTNERSHIPS

In this standard form of partnership, all of the partners are equally
responsible for the business’s debts and liabilities. In addition,
all partners are allowed to be involved in the management of the company.
In fact, in the absence of a statement to the contrary in the partnership
agreement, each partner has equal rights to control and manage the
business. Therefore, unanimous consent of the partners is required for all
major actions undertaken. Be advised, though, that any obligation made by
one partner is legally binding on all partners, whether or not they have
been informed.

LIMITED PARTNERSHIPS

In a limited partnership, one or more partners are general partners, and
one or more are limited partners. General partners are personally liable
for the business’s debts and judgments against the business; they
can also be directly involved in the management. Limited partners are
essentially investors (silent partners, so to speak) who do not
participate in the company’s management and who are also not liable
beyond their investment in the business. State laws determine how involved
limited partners can be in the day-to-day business of the firm without
jeopardizing their limited liability. This business form is especially
attractive to real estate investors, who benefit from the tax incentives
available to limited partners, such as being able to write off
depreciating values.

ADVANTAGES OF FORMING A PARTNERSHIP

Collaboration.

As compared to a sole proprietorship, which is essentially the same
business form but with only one owner, a partnership offers the advantage
of allowing the owners to draw on the resources and expertise of the
co-partners. Running a business on your own, while simpler, can also be a
constant struggle. But with partners to share the responsibilities and
lighten the workload, members of a partnership often find that they have
more time for the other activities in their lives.

Tax advantages.

The profits of a partnership pass through to its owners, who report their
share on their
individual tax returns. Therefore, the profits are only taxed once (at
the personal level of its owners) rather than twice, as is the case with
corporations, which are taxed at the corporate level and then again at the
personal level when dividends are distributed to the shareholders. The
benefits of single taxation can also be secured by forming an S
corporation (although some ownership restrictions apply) or by forming a
limited liability company (a new hybrid of corporations and partnerships
that is still evolving).

Simple operating structure.

A partnership, as opposed to a corporation, is fairly simple to establish
and run. No forms need to be filed or formal agreements drafted (although
it is advisable to write a partnership agreement in the event of future
disagreements). The most that is ever required is perhaps filing a
partnership certificate with a state office in order to register the
business’s name and securing a business license. As a result, the
annual filing fees for corporations, which can sometimes be very
expensive, are avoided when forming a partnership.

Flexibility.

Because the owners of a partnership are usually its managers, especially
in the case of a small business, the company is fairly easy to manage, and
decisions can be made quickly without a lot of bureaucracy. This is not
the case with corporations, which must have shareholders, directors, and
officers, all of whom have some degree of responsibility for making major
decisions.

Uniform laws.

One of the drawbacks of owning a corporation or limited liability company
is that the laws governing those business entities vary from state to
state and are changing all the time. In contrast, the Uniform Partnership
Act provides a consistent set of laws about forming and running
partnerships that make it easy for small business owners to know the laws
that affect them. And because these laws have been adopted in all states
but Louisiana, interstate business is much easier for partnerships than it
is for other forms of businesses.

Acquisition of capital.

Partnerships generally have an easier time acquiring capital than
corporations because partners, who apply for loans as individuals, can
usually get loans on better terms. This is because partners guarantee
loans with their personal assets as well as those of the business. As a
result, loans for a partnership are subject to state usury laws, which
govern loans for individuals. Banks also perceive partners to be less of a
risk than corporations, which are only required to pledge the
business’s assets. In addition, by forming a limited partnership,
the business can attract investors (who will not be actively involved in
its management and who will enjoy limited liability) without having to
form a corporation and sell stock.

DRAWBACKS OF FORMING A PARTNERSHIP

Conflict with partners.

While collaborating with partners can be a great advantage to a small
business owner, having to actually run a business from day to day with one
or more partners can be a nightmare. First of all, you have to give up
absolute control of the business and learn to compromise. And when big
decisions have to be made, such as whether and how to expand the business,
partners often disagree on the best course and are left with a potentially
explosive situation. The best way to deal with such predicaments is to
anticipate them by drawing up a partnership agreement that details how
such disagreements will be dealt with.

Authority of partners.

When one partner signs a contract, each of the other partners is legally
bound to fulfill it. For example, if Anthony orders $10,000 of computer
equipment, it is as if his partners, Susan and Jacob, had also placed the
order. And if their business cannot afford to pay the bill, then the
personal assets of Susan and Jacob are on the line as well as those of
Anthony. And this is true whether the other partners are aware of the
contract or not. Even if a clause in the partnership agreement dictates
that each partner must inform the other partners before any such deals are
made, all of the partners are still responsible if the other party in the
contract (the computer company) was not aware of such a stipulation in the
partnership agreement. The only recourse the other partners have is to
sue.

The Uniform Partnership Act does specify some instances in which full
consent of all partners is required:

• Selling the busigood will
• Decisions that would compromise the busiability to function normally
• Assign partnership property in trust for a creditor or to someone in
  exchange for the payment of the partnership’s debts
• Admission of liability in a lawsuit
• Submission of a partnership claim or liability to arbitration

Unlimited liability

. As the previous example illustrated, the personal assets of the
partnership’s members are vulnerable because there is no separation
between the owners and the business. The primary reason many businesses
choose to incorporate or form limited liability companies is to protect
the owners from the unlimited liability that is the main drawback of
partnerships or sole proprietorships. If an employee or customer is
injured and decides to sue, or if the business runs up excessive debts,
then the partners are personally responsible and in danger of losing all
that
they own. Therefore, if considering a partnership, determine your assets
that will be put at risk. If you possess substantial personal assets that
you will not invest in the company and do not want to put in jeopardy, a
corporation or limited liability company may be a better choice. But if
you are investing most of what you own in the business, then you
don’t stand to lose any more than if you incorporated. Then if your
business is successful, and you find at a later date that you now possess
extensive personal assets that you would like to protect, you can consider
changing the legal status of your business to secure limited liability.

Vulnerability to death or departure.

Unlike corporations, which exist perpetually, regardless of ownership,
general partnerships dissolve if one of the partners dies, retires, or
withdraws. (In limited partnerships, the death or withdrawal of the
limited partner does not affect the stability of the business.) Even
though this is the law governing partnerships, the partnership agreement
can contain provisions to continue the business. For example, a provision
can be made allowing a buy out of a partner’s share if he or she
wants to withdraw or if the partner dies.

Limitations on transfer of ownership

. Unlike corporations, which exist independently of their owners, the
existence of partnerships is dependent upon the owners. Therefore, the
Uniform Partnership Act stipulates that ownership may not be transferred
without the consent of all the other partners. (Once again, a limited
partner is an exception: his or her interest in the company may be sold at
will.)

CHOOSING A PARTNER

Because of the need for compromise and the dynamics of shared authority
that come along with sharing a business, partnerships can be very
difficult to maintain and run efficiently. Therefore, the single most
important decision a small business owner has to make when forming a
partnership is the choice of a partner. In fact, warns Edward A. Haman, in

How to Write Your Own Partnership Agreement

, “you should only take on a partner if you absolutely need that
person’s money or expertise.” As an alternative, he advises,
you could try to “get the money as a loan, or hire the person as a
consultant to get the expertise.” But if you decide that forming a
partnership is the best choice, consider the following when selecting a
partner (anyone may become a partner, except minors and corporations):

ASSETS

• How much does your partner own in personal assets? If you own much more
  than your partner, then creditors will come after you in the event of
  extensive debts.

PERSONALITY

• Do you possess compatible personality types?
• How do you each deal with stress?
• How do you make decisions? Does your prospective partner tend to talk
  things through with others or make impulse decisions?

ROLES

• What role do each of you intend to take in the business? Are these roles
  compatible? Do you both hope to be in charge of the accounts or dealing
  with vendors, for example? Or can you split up the duties in a way that
  satisfies both of you?

SHARING RESPONSIBILITIES

• How much time will your partner contribute to the enterprise?
• Can you count on you partner to show up to work on time? Or you will be
  expected to cover for him?
• Is your prospective partner a hard worker, or will he or she routinely
  leave tasks for you to complete?

GOALS FOR THE BUSINESS

• How do each of you envision the future of the business? Do you hope to
  build up a solid business and then expand to other locations? Does your
  partner share that vision or does he or she hope only to be able to make
  a decent living out of one business with fewer responsibilities than
  would be required if running a chain of stores?

FORMING A PARTNERSHIP

RESERVING A NAME

The first step in creating a partnership is reserving a name, which must
be done with the secretary of state’s office or its equivalent.
Most states require that the words “Company” or
“Associates” be included in the name to show that more than
one partner is involved in the business. In all states, though, the name
of the partnership must not resemble the name of any other corporation,
limited liability company, partnership, or sole proprietorship that is
registered with the state

THE PARTNERSHIP AGREEMENT

A partnership can be formed in essentially two ways: by verbal or written
agreement. A partnership that is formed at will, or verbally, can also be
dissolved at will. In the absence of a formal agreement, state laws (the
Uniform Partnership Act, except in Louisiana) will govern the business.
These laws specify that without an agreement,
all partners share equally in the profits and losses of the partnership
and that partners are not entitled to compensation for services. If you
would like to structure your partnership differently, you will need to
write a partnership agreement.

It may be advisable to consult a lawyer before drafting the agreement, but
you should at least research the issue on your own. A thorough partnership
agreement should generally cover the following areas:

• Name and address
• Duration of partnership—You can specify a finite date on which
  all business will terminate or you can include a general clause that
  explains the partnership will exist until all partners agree to dissolve
  it or a partner dies.
• Purpose of business
• Partners’ contributions—These may be in cash, property or
  services. Be sure to determine the value of all non-cash contributions.
• Partners’ compensation—Determine how profits will be split
  up and how often. Also decide if any of the partners will receive a
  salary.
• Management Authority—Will partners be able to make some decisions
  on their own? Which decisions will require the unanimous consent of all
  partners?
• Work hours and vacation
• Kinds of outside business activities that will be allowed for partners
• Partner withdrawal—Decide how the death, retirement, withdrawal,
  disability, or death of a partner will be handled through a buy-sell
  agreement. Also determine whether or not a partner who has simply
  withdrawn will be allowed to operate a competing business.
• Disposition of the partnership’s name if a partner leaves
• How to handle disputes—Decide whether or not mediation or
  arbitration will be provided for in the case of disputes that cannot be
  resolved amongst the partners. This is a way to avoid costly litigation.

RIGHTS AND RESPONSIBILITIES OF PARTNERS

The Uniform Partnership Act defines the basic rights and responsibilities
of partners. Some of these can be changed by the partnership agreement,
except, as a general rule, those laws that govern the partners’
relationships with third parties. In the absence of a written agreement,
then, the following rights and responsibilities apply:

RIGHTS

• All partners have an equal share in the profits of the partnership and
  are equally responsible for its losses.
• Any partner who makes a payment for the partnership beyond its capital,
  or makes a loan to the partnership, is entitled to receive interest on
  that money.
• All partners have equal property rights for property held in the
  partnership’s name. This means that the use of the property is
  equally available to all partners for the purpose of the
  partnership’s business.
• All partners have an equal interest in the partnership, or share of its
  profits and assets.
• All partners have an equal right in the management and conduct of the
  business.
• All partners have a right to access the books and records of the
  partnership’s accounts and activities at all times. (This does
  not apply to limited partners.)
• No partner may be added without the consent of all other partners.

RESPONSIBILITIES

• Partners must report and turn over to the partnership any income they
  have derived from use of the partnership’s property.
• Partners are not allowed to conduct business that competes with the
  partnership.
• Each partner is responsible for contributing his or her full time and
  energy to the success of the partnership.
• Any property that a partner acquires with the intention of it being the
  partnership’s property must be turned over to the partnership.
• Any disputes shall be decided by a majority vote.