A partnership contains many of the features of a sole proprietorship, except it is owned by two or more people. Partnerships can be organized as general partnerships or limited partnerships. Usually when we discuss partnerships, we are talking about general partnerships. Limited partnerships are much more complicated to create and have their own administrative complexities. Limited partnerships are usually not the best choice unless there are several passive investors who wish to have a monetary interest in the partnership but little-to-no managerial powers, especially in the day to day operations of the business.
Like sole proprietorships, partnerships are easy to organize, they are flexible, and they maintain privacy. Taxation is fairly simple, as the profits “pass through” the partnership to the partners. Basically, the partnership itself pays no taxes, but each partner claims his share of the profits on his personal tax return. This helps avoid the double taxation disadvantage of corporations.
Partnerships are governed according to the partnership agreement. It is very important to hire a lawyer so that you can make sure you and your partners know what you are agreeing to and what responsibilities and duties each partner has. Do not fall into the trap of believing that you and your partner are best friends and you can always work out any issues. Although we usually do not want to think about what we will do if the business fails, a lawyer can help you protect yourself in the partnership agreement in case things go south—and issues always arise. Many unforeseen problems emerge later in a partnership and the partnership agreement determines in advance how to handle those situations. For example, what happens to one partner’s portion of the company if he becomes disabled? It is also important to plan what will happen if one of the partners wants to leave and how conflicts should be resolved. When partners fail to write effective agreements, one partner will often end up with the short end of the stick, or one partner will not get out of the business what it expected to get out if the business is forced to close. A well written partnership agreement will cost much less than legal fees if an issue arises.
On the other hand, from a liability perspective, a partnership is almost never a good choice. A partnership, like a sole proprietorship, exposes its owner to personal liability for the debts, losses, and liabilities incurred by the business. Partners are not only liable for their own actions as partners, but for the actions of the other partners in the name of the partnership. If one of the partners racks up a lot of debt in the name of the partnership, or binds the partnership into terrible business contracts, the other partner’s personal assets may be seized to satisfy the obligation. Furthermore, those who would sue the partnership can choose which partner they want to sue, potentially recovering everything from one partner and nothing from the others.