Can a Partnership be a Small Business?

Each day, business partnerships are formed across the country. When this occurs, two or more individuals team up in order to go into business together. Prospective business partners usually project that they have a better chance of earning a profit together than apart. Therefore, they are expected to share both the profits and losses with each other.

By: Brad Nakase, Attorney

Email | Call 800-484-4610

When entrepreneurs size up their options, they will find that there are many different types of business partnerships. Each of these offers advantages and disadvantages of all different kinds. So how do individuals settle on a kind of partnership and a business structure that works for them? This depends on business preferences, the industry of which the business is a part, and the need for liability protection, among other important factors.

Many wonder if business partnerships can be considered “small businesses.” The answer is yes, but to understand how and why it is important to take a detailed look at the nature of small business partnerships. Here, we will provide essential details about the types of partnerships out there and also some other pertinent information for entrepreneurs and interested small business owners. Read on if you are curious about how partnerships can become small businesses.

Choose a Type of Business Partnership

When forming a business partnership, one of the most important choices one must make is deciding on what type of partnership to go with. Various systems offer different advantages and disadvantages, such as different levels of liability protection, which is an important distinction to make. Since the filing process is also different depending on the state, prospective business partners should make sure to be familiar with all of the relevant information.

We recommend checking on the laws, rules, and requirements that govern businesses in your state. Eager entrepreneurs can run searches online, contact state offices and the secretary of state, and network with colleagues to find out what partnerships are available where they are. It will also help to contact a licensed business attorney from your state or area. In order to understand the nature of business partnerships, it is helpful to be familiar with both limited and general partners, so let’s take a look at those first.

General Versus Limited Partners

General partners are known to manage a company’s daily operations. General partners, therefore, have a strong sense of authority and are mainly responsible for the nuts and bolts of the business. Limited liability limited partnerships, or LLLPs, Limited liability partnerships, LLPs, and general partnerships feature general partners. While general partners do enjoy being responsible for the business, they also must assume the risk of personal financial liability, to at least some extent.

Next up: limited partners. Limited partners are known as “silent partners” because they are usually only there to invest in the business. While they provide the necessary funding, they are not generally involved in running business operations or making daily decisions. Sometimes, investors seek to be limited partners to protect their personal assets from the company’s liabilities. LLLPs and LPs both feature limited partners as a part of their structure.

General Partnerships

General partnerships are often formed in the business world because of their renowned accessibility. Since general partnerships do not necessitate registration or too much time-consuming paperwork, they can be formed and started up fairly easily. However, there is one thing that all partnerships rely on and benefit from a thorough partnership agreement.

When a general partnership is created, all of the partners are considered personally liable for the company’s financial obligations. This means that partners’ personal assets can be placed at risk if a lawsuit occurs and someone sues the company. This drawback must be considered when deciding which business structure to go with.

We strongly recommend that entrepreneurs only form a general partnership with others if they trust the other partners wholeheartedly. While you do not technically need to be “friends” with your partners, you should feel that they have your best interests. If they do not, then you could become liable for careless mistakes that others have made or errant business decisions. When you are a part of a general partnership, decisions like this and mistakes are shared in the same way that profits are, so make sure to select your general partnership with the utmost care and do your research and due diligence. Several additional types of business partnerships offer limited liability to partners, so stay tuned.

Limited Partnerships

LPs, or limited partnerships, consist of two unique partners. These are limited partners and general partners. Limited partners provide funding in the form of business investments, but they are known as “silent partners.” This means they do not involve themselves in daily company operations, and they do not have a hand in managing the business. These limited partners are also able to take advantage of limited liability since they are only responsible for the company’s liabilities at the rate they have invested.

As opposed to the limited partners, the general partners in a limited partnership assume unlimited liability. This means that if there are company debts to be collected or if someone sues the business, the assets belonging to the general partners can be at risk.

Sometimes, limited company partners slowly begin asserting themselves and managing the day-to-day business tasks. This is something to stay aware of and be careful of because if limited partners are involved with daily business tasks, they can be seen as helping to run the business and, therefore, not “limited” anymore. At that point, their personal assets will be at risk in the same way that general partners’ assets are.

Limited Liability Partnerships

Sometimes, people confuse LLPs, or limited liability partnerships, with LPs. However, these partnerships are quite different. LPs must include a general partner with unlimited personal liability as a business structure. However, here is the key distinction: LLPs feature limited liability for all involved partners, in a similar way that an LLC offers limited liability. However, it is important to note that this limitation can vary from state to state. For example, in some states, business partners are only able to receive limited liability if another partner is negligent, and in other states, limited liability is given to LLP partners as a part of all business obligations.

It is important to check in with the rules and regulations that govern each state to make sure that you stay on top of the game. For example, only certain types of companies can create LLPs in some states, such as accountants, architects, and attorneys. LLPs are a great option for these professions because of the flexibility in adding and letting go of partners. For example, when an LLP is formed among accountants, they can gather and share their resources while reserving a sense of flexible structure. This also gives all of the partners the chance to manage the company with the all-important sense of limited liability.

Limited Liability Limited Partnerships

A newer and more modern form of partnership, an LLLP or limited liability limited partnership, puts a new spin on the idea of liability protection for its partners. This is because LLLPs feature at least one limited partner and one general partner. When they form an LLLP, all involved partners enjoy liability protection, including the general partners. This is in stark contrast to the LP structure, in which the general partners must assume unlimited personal liability. In LLLPs, the limited partners are considered silent partners, similar to the limited partners in LPs.

One major difference between an LLLP and an LLP is that LLPs do not include these limited partners, whereas LLLPs do. Real estate investors like how LLLPs let them minimize their financial liabilities, even if they become involved in the company’s daily tasks. However, it is essential to point out that LLLPs are not available in all states. If you are interested in forming an LLLP, check in with your state government and/or secretary of state to see if this unique structure is available to your partners and yourself. Now, if your business is run in several different states, this is probably not the correct structure for you. However, there are more structures out there that should work for you, so do not worry.

Partnerships: Defined

As you are probably beginning to see, business partnerships are available with many different forms of liability structures, including benefits and limitations. This makes this diverse group of partnerships very useful and sometimes confusing. If you have questions about these different structures, feel free to refer back to the start of the article. It also makes sense to contact a business attorney who can help explain the advantages and disadvantages of the different systems and even help you to select the ideal partnership for your new business. Next, we will delve into the fundamentals of these partnerships, the nature of joint ventures, the ins and outs of partnership agreements, and more. Stay with us as we continue answering one of the questions we are constantly asked: can a partnership legitimately be a small business?

The Fundamentals of Partnerships

Before forming a partnership, make sure to select your would-be partners carefully. Entering into a partnership with business partners you know and trust can be the difference between a new company that exceeds expectations and one that is riddled with problems and never gets off the ground. Partnerships are generally easy to create, but the key is to not get carried away and forget to thoroughly vet your partners. Also, we recommend signing a business agreement or some other type of official, documented agreement that will serve to guide the behavior of the involved parties and, therefore, the entire company.

If there is no written agreement, the partners may try to follow the partnership’s specific rules, but it is much easier to have a document to refer back to, one that all of the partners created, agreed upon, and signed. Since all involved business partners share the exact extent of authority, and since the partnership is therefore bound together by both debt obligations and partners’ business dealings, it is crucial to choose business partners wisely.

It is worth noting that business partnerships are not for everyone, and just because you are friends or acquaintances with someone, that does not mean that you will make good business partners. Resist the urge to speed through the step in which you choose your partners, even if you are excited to provide your business idea with a platform and begin creating revenue. Excellent business partners complement each other with their talents and skills and create a union that is greater than the sum of its parts. That is why you should form a partnership instead of simply for convenience.

Trying Out Joint Ventures

Are joint ventures also business partnerships? It is tempting to think of joint ventures in this manner, and many of us do, but there are fundamental differences between these different systems. For example, joint ventures, which consist of two or more companies who band together to support a unique, specific business project, are usually devoted to one standardly defined aim. However, partnerships are usually based on a long-term outlook and are fueled by multiple objectives and ambitions.

Also, joint ventures usually feature two or more parties that are businesses, not individual people. These businesses are focused on one specific outcome, and they have decided to strategically get together in order to fund a new pursuit, be it research, products, or services. Sometimes, these ventures are based on the unique combination of value each company brings to the collaboration, and joint ventures can be useful in breaking into new markets.

Unlike partnerships, joint ventures find order and structure in their contract. This shared contract allows members to identify both their duties and their liabilities. In a joint venture, the parties can choose whichever legal structure they would prefer, be it a corporation or a partnership. Once a joint venture accomplishes its goal, it usually is dissolved as the parties go on to other pursuits. Ideally, the parties are satisfied and happy that they began their joint venture business journey.

The Basics of Partnership Agreements

No matter the structure that is chosen, one essential aspect of all partnerships is a signed operating agreement. Contracts such as this are necessary to help protect partnerships from disputes. If a dispute, for example, comes down to one partner’s claim over another’s, it is easy to reference the contract to see who is right and who is wrong. Contracts usually include, but are not limited to:

A concise explanation of each partner’s duties
The preferred manner of distributing profits
The powers of the partners to conduct business decisions
A clause for dispute resolution
An agreement for a possible buyout
An exit strategy: for example, this may be a detailed description of how partners can withdraw from the company and can also dictate how much notice is needed for leaving the business. Also, this part of the contract can detail the way in which the partnership would handle an unfortunate circumstance such as a partner dying, retiring, or leaving the company for another reason.
The way in which to bring in a new partner for the business
Other issues that may be important to your unique business.

Also called a partnership agreement, this document is necessary for all partnerships. Therefore, the operating agreement creates and establishes rules for the business that would be up to the state’s default guidelines without it. When an operating agreement is written in the right way, it should enable the business partners to operate their companies according to their preferences, and that can undoubtedly help the business. Also, a state’s default rules sometimes do not suit a particular business, and that is why a contract is so important.

We recommend taking your time in creating the contract and making sure that all of the partners have a chance to contribute to it and read it over before it is finalized. Great partnerships begin and end with excellent, thorough, and inclusive contracts, so do not overlook or skimp on this step.

Explaining Liabilities to Creditors

Did you know that business owners are personally responsible for the entirety of the partnership’s financial obligations and debts? This means that, unfortunately, if it comes down to it, creditors and other agencies can pursue assets belonging to partners to settle their debts and attain the money the creditors are owed. In this scenario, creditors can seek out the involved business partners’ cars, homes, and even bank accounts. Essentially, this is the most potentially damaging trait of partnerships and also what many see as its main drawback.

Now, for limited partners who have only invested money into the partnership, and that is it, there can occur an exception to this type of personal liability. Limited partners can file a special certificate that stipulates their limited role and must include the names of all of the partners. Limited partners are still allowed to be personally sued by creditors if this document is not created and signed, even if the limited partners are only seen as investors and other partners who run the company. Therefore, this limited partnership certificate is essential.

Lastly, any debt owed by the business to creditors can be collected by one single partner. This is what is meant by the phrase “joint and several liabilities,” which implies that each business partner is individually responsible for the entire debt. Why is this enforced? This “joint and several liabilities” simply prevents partners from forcing each other to pay the whole debt. Another important note: if one partner does pay the entirety of the owed debt, they can and should sue the other partners in order to only pay for part of it and collect their fair share. For more questions about these circumstances, it is wise to contact a business lawyer.

Essential Duties to Partners

Every legal relationship comes with responsibilities, correct? In this case, the legal union with your business partners means that you owe them specific duties. These may include but are not limited to:

No salary and equal control unless there is a different agreement in place
Loyalty to the other partners as well as fiduciary duty
Profit-sharing with the other partners is equal in nature unless a prior, written, and signed agreement has already established a different set of circumstances.

What is meant explicitly by a duty of loyalty and/or a fiduciary duty to one’s partners? This implies that all business partners involved in the small business expect each other to act in the best interests and intentions of the partnership. As opposed to focusing on helping only themselves, partners must focus on the outcomes of the partnership, not their own accounts or wallets. Additionally, partners can be sued by the partnership if financial wrongdoing is suspected and proven, and business partners also have to be able to provide financial accounting for all of the actions they have taken. While these circumstances are somewhat rare, and we hope that your new partnership does not have to deal with lawsuits or financial disagreements, we suggest keeping careful, thorough records of each business deal.

How Partnerships are Taxed

One of the advantages of partnerships is that they are able to utilize flow-through taxation. What is flow-through or pass-through taxation? This means that the partnership does not have to pay taxes itself. Similar to a sole proprietorship, the partners themselves pay taxes on their own unique share of the profits, using their annual personal income tax returns. How is this possible? It is simple. The business partnership is not a specific corporate entity, like an LLC, so the taxes only need to be paid through the partners’ taxes. But, of course, the partnership still provides tax information to the Internal Revenue Service.

Sometimes, companies decide to be a “business partnership” to take advantage of flow-through taxation. While forming a corporation is popular, corporations enjoy other advantages; they something must pay double taxation. Double taxation occurs when a corporation pays its corporate taxes, and then its shareholders have to also pay taxes. Because this idea of double taxation can hurt revenue, more and more companies have decided to become business partnerships.

How to Terminate a Partnership

We always recommend beginning a business partnership—and therefore, creating a small business—with the backing of a written agreement. One of the reasons for this is that this document makes the termination of a partnership easier. When the partners decide to permanently suspend and disband the partnership, it is usually because one of the events that were written about in the agreement has occurred. Sometimes, a partnership ends because one partner gives notice that they wish to leave. This is called “dissociating” from the partnership, and it can create a veritable domino effect as the rest of the partners decide to also end the partnership. Or, if there are only two partners, there is sometimes not much choice to be had when one partner decides to formally leave.

Regardless of the existence of a written agreement, it is usually simple to leave a partnership if you are certain it is time to do so. But, of course, individuals who leave are still held responsible for business obligations that were a part of the partnership and incurred while the partner was still at the company.

While it can be a relatively straightforward process, leaving your partnership is still a process. Since there are usually debts to be paid and other obligations to take care of, such as dealing with office space, company vehicles, and bank accounts, the business needs to be treated with care and formality in its last days.

Contacting a Business Attorney

Starting a small business partnership can be an exciting and lucrative task. Since a business partnership has many different facets, it is a wise idea to contact a business lawyer. A licensed attorney can help individuals stay up to date and informed about the rules and regulations that govern business partnerships in their particular state. In California, we invite you to contact Nakase Wade for a free consultation regarding your exciting new partnership. We have helped many small businesses accomplish all of the tasks necessary to start the company, and we look forward to finding out how we can help your new small business.