What is a General Partnership?
How does a general partnership work?
What are the essential elements you should know!
In this article, I will break down the notion of General Partnership so you know all there is to know about it!
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Let me explain to you what are general partnerships so you understand how it works!
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What Is A General Partnership
General partnership refers to a business structure where you have two or more business partners combining their skills, time, and resources to establish and operate a business.
In a general partnership, the business owners (the partners) agree to start and run a business where they share all the assets, profits, and liabilities from their business operations.
Unlike other business structures like corporations and limited liability companies, you do not need to file any forms or documents with the state to create a general partnership.
The mere fact that you collaborate with another partner, combine your resources and work towards a common commercial objective, you are considered to be in a general partnership.
In other words, a general partnership is simple to form and operate.
If you intend on starting a small business that presents a low level of risk and you trust your business partners, general partnerships can be a quick and easy method for you to get the business up and running.
General Partnership Definition
How do you define a general partnership?
According to Investopedia, a general partnership can be defined as follows:
A general partnership is a business arrangement by which two or more individuals agree to share in all assets, profits, and financial and legal liabilities of a jointly-owned business.
Based on this definition, we can summarize a general partnership as:
- An arrangement between two ore more people
- Who agree to do business
- Share profits
- Share expenses and liabilities
How Does A General Partnership Work
How does a partnership work?
General partnerships (or GPs) are very simple business structures to form.
Many consider general partnerships to be right for them as they do not want to have to deal with complicated paperwork to form their business structures, be directly involved in the business, and have the flexibility to manage the business as they desire.
General Partnership Requirements
For a general partnership to be formed, here are the requirements that you need to satisfy:
- You need to have at least two partners
- The partners agree that they will each share all business profits
- The partners agree that they will each share all business liabilities
Although it’s not mandatory to have a partnership agreement, it’s highly recommended for the partners to get into a general partnership agreement where they agree on the terms and conditions governing their partnership.
Keep in mind that a general partnership does not need to have a partnership agreement for it to be legally formed.
An oral agreement can legally give rise to a general partnership.
General Partnership Characteristics
When you’re in business with other partners, you should consider the following general partnership characteristics:
- A general partnership can be formed when at least two individuals get together for a commercial enterprise
- The general partnership is easy to form where you do not have a lot of paperwork to manage
- A general partnership can be formed orally or through a partnership agreement
- The general partnership is not a separate legal entity from the partners
- The general partnership allows for business revenues to flow through to the partners
- The general partners are entitled to all business profits but are responsible for all business liability
- The general partners are responsible for the actions of other general partners
For certain types of businesses, the simplicity of the business structure, flow-through taxation, and high level of engagement by the partners in the business leads the partners to form a GP.
However, for businesses that are risky and can result in significant liability, you may want to assess your options before finalizing your decision on a GP.
Partners’ Joint Liability
General partners in a general partnership should be mindful of the fact that they will have joint liability with the other general partners.
This means that every partner in a general partnership will have unlimited liability for:
- The consequences of their own actions
- The consequences of the actions of the other partners that bind the partnership
- The consequences of the actions of the partnership employees
This form of liability where one general partner is responsible for another is called joint liability.
When operating a general partnership, the partners must recognize that they will need to act in the best interest of the partnership to avoid putting themselves in a situation where they may be pursued by the other partners.
Each partner has to observe fiduciary duties.
There are four types of fiduciary duties to observe, which includes:
- Duty of good faith and fairness
- Duty of loyalty
- Duty of disclosure
- Duty of care
From the moment the general partnership is formed until it is dissolved, the partners have to observe their fiduciary duties.
General Partnership Management
General partnerships can be formed without the necessity of having a general partnership agreement in place.
However, partners can choose to agree on management and control terms and conditions allowing them to manage their partnership for the long term.
In a general partnership agreement, you can:
- Define each partner’s roles and responsibilities
- You can define voting rights
- Determine the formula for distributing profits between partners
- Determine who will be the managing partner
- Determine the process for changing the partnership agreement terms
General Partner Compensation
General partners in a general partnership can get compensated for their services.
However, general partners are not necessarily employees and their compensation is not considered a “salary”.
Instead, general partners receive “partnership distributions” which is a share in the partnership profits.
Typically, each partner will receive his or her share of the profits as outlined in the partnership agreement (or based on the formula defined there).
When the partner receives a distribution, the amount will need to be reported by the partner on his or her personal income taxes.
The general partnership distribution is taxed like self-employment income and will be subject to self-employment taxes for Social Security and Medicare.
General Partnership Taxes
General partnerships are pass-through entities where the business income flows from the general partnership to each individual partner.
In other words, the general partnership does not have to pay business taxes on the revenues it generates.
The business revenues are passed along directly to the general partners who report the distributions on their personal income taxes.
The general partnership will need to complete a Schedule K-1 for each business owner.
Then, each general partner will use Schedule K-1 to complete Form 1040.
The partnership will also need to file Form 1065 every year to provide additional information about the partnership to the tax authorities.
General Partnership Pros And Cons
What are the advantages and disadvantages of operating a general partnership?
Let’s start by looking at the advantages of general partnerships.
General Partnership Advantages
One important advantage in operating a general partnership is that it is easy to form.
General Partnership Structure
Fundamentally, all you need is a verbal agreement between the partners to form a general partnership.
In other words, you do not need to file any paperwork with the government to formally create a general partnership nor do you need to have extensive documentation with your business partners.
Consider a general partnership to be a sole proprietor partnering with another sole proprietor where they both benefit from the business profits but also share all the liabilities.
Another advantage of general partnerships is the simplified manner to handle their taxes.
Just like sole proprietors, geneal partners do not have a separate business tax return to file.
When doing their personal taxes, general partners will report their share of business profits and pay taxes on their personal tax returns.
In business lingo, we refer to this as flow-through taxation (the business revenues flow directly to the general partners who pay taxes on their personal tax returns).
This means that the general partnership does not have double taxation as corporations do and does not have to file a separate tax return from the business owners.
General Partnership Dissolution
For some doing business, the simplicity of the dissolution of the business structure can be an important consideration if things do not work or if you wish to incorporate the business in the future.
General partnerships are easy to dissolve as they are easy to form.
You do not have extensive paperwork to file like corporations and other business entities.
All you need to do is to notify the tax authorities that you are dissolving your partnership and inform those you do business with like vendors and clients.
General Partnership Disadvantages
Although there are important advantages in operating a business as a general partnership, you should also consider the disadvantages of this business structure.
One disadvantage of general partnership structures is that they do not afford the partners (or business owners) with personal asset protection.
This means that unlike operating a business under a corporation, general partnerships are not considered separate and apart from their business owners.
As a result, a business creditor may file a lawsuit against the partnership to recover any debt or liability but can also pursue the general partners personally to recover any outstanding debt.
For this reason alone, many choose to incorporate their business to have the personal liability protection offered by corporations considered as separate entities.
Partners Liable For Others
A second key disadvantage of general partnerships is that each general partner can be held liable for the actions and conduct of other partners.
This means that general partners are not only liable for the business but also for the conduct of the other general partners.
For example, if a general partner signs a contract or performs certain transactions without the authorization of the other, the other general partners can be held accountable for that transaction.
Some may not want to become a partner in a business where they can be held accountable for another partner’s actions.
In contrast, in a corporation, a shareholder will not be accountable for the conduct of another shareholder.
To prevent disagreements between the partners, many will choose to enter into a partnership agreement where the partners define their roles and responsibilities and even determine instances that a partner may potentially be kicked out of the business.
General Partnership Examples
Let’s look at an example of general partnerships to better understand what it is and how it works.
Imagine that Mary and John are interested in starting a small business baking cookies for the neighborhood.
Since they will operate the business on a small scale, they do not want to go through the trouble of incorporating a company, incurring a lot of costs, and then having a lot of red tape to maintain the corporation active.
They want to start the business in a simple way and they will share everything 50/50.
Mary and John start baking cookies, advertising them in their area, and earning revenues.
As simple as that, Mary and John have formed a general partnership where they are each general partners.
They are both entitled to half of the business profits but will equally share all the business costs, expenses, and liabilities.
General Partnership Meaning Takeaways
So there you have it folks!
What is a general partnership in business?
How do you define general partnership?
A general partnership is an unincorporated form of business composed of at least two business partners sharing profits, responsibilities, and liabilities.
In summary, each general partner in a general partnership is entitled to share the business profits but will also need to assume responsibility for business losses.
General partnerships are not separate legal entities from the business owners and as a result, are simpler to form and general partners will not have separate tax returns to file.
On the other hand, each general partner will have unlimited liability for the financial obligations of the business and its liabilities where his or her personal assets can be subject to a lawsuit.
In addition, each general partner can be held liable for the errors and omissions of other general partners making this type of business venture slightly risker.
If you want to know whether a general partnership is right for you, it’s best that you consult with a business lawyer or professional to get some advice.
Remember, this article is intended to give you general information to get you started in your research and investigation.
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Understanding General Partnership
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