Don’t be a General Partner! (Not Even by Accident)
A partnership is the most basic and perhaps the oldest type of business formation, and quite simply the easiest to enter into. In fact, it is so easy to enter into, you may enter into without even knowing it. Anyone you share profits with could legally be your partner, and your partner is legally obligated to the debts of your business.
There are only two business formations that do not require any paperwork to be filed with the State: a sole proprietorship and a general partnership. A sole proprietorship has a single owner and operator for the business. If there is more than one person running the business, then they might be general partners, even if no paperwork has been filed.
In a general partnership, each partner has an equal share, unless the partners agree otherwise in writing. Each partner has the authority to act as an agent of the partnership and bind the partnership to contracts with third parties. Each partner is limited in what they can bind the partnership to. They can only do things in the regular course of business, and cannot expand or bind the partnership to obligations not related to the business. The partners’ voting rights for partnership decisions are the same as their share of the partnership. A partnership with only two partners cannot make any major decisions without both votes, unless the partners agree otherwise in writing.
Every aspect of the partnership can be modified in writing, and all the above default rules can be changed. Partners can decide in writing when forming the partnership all the details of the relationship.
A general partnership provides no protection from liability. In fact, a partnership spreads liability around jointly and severally between all partners. Joint and several liability means that any one of the partners is liable for the debts of all the partners. A general partnership is risky because there is no protection from liability, and no protection of the partners’ personal assets. So why would anyone form a general partnership?
General partnerships can be formed in law without the parties intending to do so. The number one thing the court will look for when deciding if a partnership has been formed is the sharing of profits. If two people are sharing the profits of a business then they are probably partners, and would both be liable for the debts of the partnership. It is not always clear though if profits are being shared or if profits are being used to pay back a debt or to pay an employee.
For example, most businesses require some startup capital. When a person invests in the business, they are not a partner just because the loan they made is repaid out of the profits of the business. However, if the profits will continue to be shared even after the loan has been fully repaid, then the lender may actually be a partner. Maybe the additional sharing of profit is interest on the loan, but the court will scrutinize whether there is a partnership.
The court will also look to other aspects of the business organization:
• Control over the day to day operations
• Sharing in losses of the company
• Control over the purpose of the business
• Whether the parties intended to form a partnership
• Undertaking a joint venture
So why would anyone form a partnership? A general partnership should not be formed on purpose! There are many alternatives to general partnerships that do offer protection from personal liability for the debts of the business. There is always a limited liability company (LLC), which is a business entity that is very popular for many reasons. Read more on LLCs here. If you still want the flexibility of a partnership but not an LLC, there is Limited Liability Partnerships (LLP), which operate similar to an LLC. The partners of an LLP are still general partners, but they are not personally liable for the debts of the partnership. There is also Limited Partnerships (LP), which consist of a limited partner who is only liable for the amount they have contributed to the partnership, and a general partner. Often in the LP form the general partnership share is owned by another company that is shielded from liability, such as an LLC. Similarly, there is also a Limited Liability Limited Partnership (LLLP). For more information on partnerships, read our previous blog post.
If you are going into business, you should consult an experienced attorney to assist with forming the right business association for your purpose. The attorneys at Law 4 Small Business can help with any formation you need, and guide you with all your choices.