By Fernando Berrocal
In the startup and small business world, you’ll hear the term “general partnership” used frequently. What does it mean, though? A general partnership (GP) is primarily a contract between two or more people who agree to split all earnings, obligations, and assets of a future business.
What are the risks of a general partnership?
Due to a general partner's unlimited liability, GPs have the potential to be dangerous. Therefore, both partners might lose their assets in a hypothetical situation where an unsatisfied customer sues only one partner. In essence, a general partnership requires two partners who are willing to assume each other's obligations–without exception. In a GP, verbal agreements are valid; however, both parties should try to retain thorough documentation of agreements. When it comes to taxes, each partner pays their fair share and files their own tax returns.
How are GPs organized?
Generally, in a general partnership each partner is permitted to enter into an agreement or business deal on their own–even if all partners share in profits and liabilities. The other partners are required by law to follow the provisions of the agreement. Since there is a potential for conflict, many GPs decide to describe how they will resolve disputes in articles of partnership. Another method to prevent disagreements is the practice of voting on important choices. The Board of Directors is a managerial and advisory group within companies that certain partnerships designate. One approach to ensure problem-solving is not exclusively dumped on one party is hiring a mediator.
It's wise to evaluate the pros and cons when choosing the structure of your startup’s leadership.
What are the benefits of general partnerships?
- In comparison to other business structures, GPs are simple to establish. Choosing a general partner might be the ideal solution for smaller businesses. Most state governments don't ask you to file any paperwork, but municipal governments may need extra information.
- GPs are less expensive to set up and also need less paperwork.
- Quick decisions can be made. A partnership offers more flexibility, since fewer levels of management need to be engaged when making major decisions.
- GPs–unlike other commercial structures–are not subject to double taxation, hence the company is not taxed.
Since each member pays taxes on their share of the partnership's profits, the GP business structure is not taxed.
The main drawbacks of GPs are:
- All partners in a GP must be accountable for the activities of the other partners on a personal level.
Being a general partner has some disadvantages–including the potential for joint liability for any debts or obligations the business incurs. Therefore, if your coworker begins making mistakes, they may drag the entire organization down. If the firm fails each partner's funds and assets are equally in danger.
How can you establish a general partnership?
Firstly, find a partner who you want to do business with. Then, you should draft your articles of association. It's better to ensure everything is spelled out and signed on paper before the formal partnership is formed. Your partnership's articles of incorporation must contain the following parts:
- Each partner’s name, as well as the location of the firm.
- The goal and the conditions of the relationship.
- When the collaboration will start, as well as when it will terminate (if applicable).
- The amount of capital each partner is contributing.
- How choices are made–and who makes them. Also, how profits are distributed.
- How the partnership will be run, and how you'll handle any potential disagreements.
How do GPs compare with other business entities?
If you're unsure whether or not a GP is the best sort of business for you, here is how it contrasts with three popular categories of corporate entities:
- GP vs. Limited Liability Partnership (LLP): An LLP allows a general partner to have limited responsibility for the business. All partners in a GP are responsible for the firm's debts as it is a legal entity. The restricted liability of an LLP, on the other hand, ensures that only one partner may be held accountable in the event of any financial issues. If you run a certain kind of business, LLPs are the greatest approach to safeguard your assets. It can be worthwhile to consider an LLP if your organization has previously been prohibited from founding an LLC. LLPs avoid double taxation in the same manner as GPs do.
- GP vs. Limited Partnership (LP): A LP is a type of business partnership with two categories of participants: general and limited. There are various obligations that pertain to both types. If you are a general partner, you are accountable for the firm. If something goes wrong, you will be held personally responsible for it–and your participation in regular activities will be impacted. It's preferable if they become a general partner and are then responsible for the business decisions if you decide to step in. Since they avoid paying double taxes, LPs are fantastic. Members just have to pay taxes once.
- GPs vs. Limited Liability Corporation (LLC): An LLC is a form of business structure that establishes a separate legal entity for the firm from the owner. Although there are many other organizational structures, there are important differences between LLCs and GPs. An LLC is far more secure than other business structures like corporations or GPs since its owners are not individually responsible for the debts or legal actions taken by the business.
All in all, structuring your small business as a GP comes with a series of pros and cons. The main benefit? GPs are simple to establish. Thus, choosing this type of business structure is a popular strategic move for startups. On the other hand, the main drawback for GP is that they must be accountable for the activities of the other partners. It’s important to have this clear before making a decision.