What is the Most Popular Type of Business Partnership?
This article will describe the different types of business partnerships and explain why different partners choose different formats. We will also go over the risks and advantages of forming partnerships so that entrepreneurs better understand whether a business partnership is the right choice.
We often hear company partnerships compared to marriages because partnerships rely on cooperation and trust. However, when partners decide to create a company together, they assume certain risks. For example, if a business partnership is sued, all partners may be found responsible.
For example, if Ted, Von, and Chris are partners, but the SEC accuses Ted of insider trading, the entire partnership must deal with the problem. If Ted is found guilty, the partnership may lose money. What’s worse, Von and Chris may lose their assets even if they did nothing wrong.
That said, business partnerships are also the right choice for many individuals. Numerous entrepreneurs find a business partnership the correct entity for their ideas and talents and enjoy lucrative business careers with their partners.
When business partnerships fail, or one partner finds themselves struggling within the company, it is sometimes because they did not know what they were getting into. So, before creating a new partnership, it makes sense for entrepreneurs to understand their various options. When entrepreneurs are informed about the nature of business partnerships, they can make an informed choice for themselves, their families, and their careers.
What is a Business Partnership?
When business partners form a partnership, they agree to be one of the multiple owners. Although partnerships are official businesses, they are not recognized as legal company entities, so registering a partnership is unnecessary.
Without these legal restrictions, many wonder how partners successfully form partnerships. The concept is simple: a company partnership is formed if one entrepreneur decides to go into business with another person.
Some states, however, do allow business partnerships to be registered. In these states, a business partnership might provide owners with liability protection for their assets. However, business partnerships are formed quickly, easily, and informally in most states. For example, new business partnerships require no formation paperwork or documentation in California.
Partnerships: Unique From Other Entities
Many wonder what makes business partnerships different from other business structures, such as limited liability companies.
The answer is that partnerships cannot be separated from their owners, financially or legally. In this way, business partnerships are similar to sole proprietorships. Any profits the business makes flow through to the company owners’ incomes. Therefore, the company’s income is personally taxable for business owners. However, that is not all that “flows through” from the company to the owners. In addition to profits, other elements pass through from the company to the owners, including:
Partnerships are viewed as easier to start and run compared to corporations. Business partnerships also typically cost the partners less to create than corporations.
Plus, all partnerships feature flow-through taxation, a method of taxation that typically creates lower tax rates than other company structures.
How Many Different Types of Business Partnerships Exist?
Seth and Franklin are award-winning Bay Area chefs who have had storied careers. The restauranters want to join forces and create a partnership for their next challenge. Seth envisions a fleet of five-star restaurants with award-winning food. Franklin dreams of restaurant success outside of California and even venturing into Europe someday.
While the two chefs have big dreams, they focus more on meal prep and seasonings than business structures, so they both have many questions. Seth wonders what type of partnership they should start. He has heard from colleagues that a general partnership is the best bet for new restaurant groups.
However, Franklin thinks he and Seth should form a limited liability company (LLC). Franklin says that it is “just what restaurants do” and that limited justification is not enough for Seth to bank on.
Partnerships: Four Unique Blueprints
Four different types of business partnerships exist, and they each offer specific advantages and disadvantages. For example, some partnerships are limited by geographical location, while others are limited by company type.
General partnerships are the most straightforward of the partnership choices. To start, one does not need to form an entity with the state. Instead, the partners sign the business into existence through their partnership agreement.
In general partnerships, each partner can bind the business. Binding the business involves making finalized agreements for loans, contracts, and other documents. All partners also possess total liability to the company. Total liability means that each partner is responsible for the company’s debts and legal responsibilities.
General partnerships give partners a lot of authority, yet they also require a lot of responsibility. For example, Owen, Mike, and Paul are the partners in a general partnership. Owen, known for his irresponsible spending, takes out a loan for half a million dollars. A few months later, Owen realizes he cannot pay off the loan and never will be able to.
In this case, because the partners formed a general partnership, all three partners can be found personally responsible for the loan payment. This issue means that Mike could lose his life savings, and Paul could lose his house based on Owen’s negligent actions.
General partnerships do offer partners the ability to form them easily and just as easily dissolve them. General partnerships usually dissolve by themselves when one partner passes away or experiences bankruptcy.
Partnerships are considered limited and authorized by the state in which they are established. Limited partnerships feature at least one general partner and one “limited” partner. The difference between the general partner and the limited partners is that the general partner runs the business, while the limited partners contribute funding.
General partners are not only responsible for the company, but they are also liable for the company’s debts. On the other hand, limited partners invest in the company but are not liable for the business’s debts.
Limited partners are often called “silent” partners because of their minimal role in the business. They provide money in exchange for returns, but the partners are protected because they cannot lose more money than they have contributed. Whether limited partners qualify for flow-through taxation depends on the state where the business is located.
Some limited partners grow too involved in the business and begin making important management decisions. However, these silent partners lose their status and protection once this happens.
For example, let’s say that Steve and Carlos have a great idea for a new company that creates ringtones in partnership with the TikTok app. Both men are entrepreneurs, but Carlos already runs his own business. However, Carlos does not want to pass up on what appears to be a lucrative business opportunity.
Steve wants to run the business by himself, at least to start, so Carlos agrees to be a limited partner. Carlos invests money, but Steve makes the decisions. Both partners are comfortable with their roles and responsibilities. As the face of the company, Steve assumes more responsibility, but he prefers being in the thick of things. Carlos is happy to be a part of the company, but he has his daily responsibilities to deal with.
When the company takes off, Steve adds another limited partner, and Tock Tick Ringtones is a hit.
Limited partnerships provide an excellent choice for entrepreneurs who can agree on specific roles and seek different things out of the company. They are also a great option for small businesses that have not yet taken off.
- Limited Liability Partnership
Partnerships considered limited liability are run similarly to general partnerships: each partner contributes to managing the business, but they are not liable for any errors made by their co-partners. Therefore, each partner possesses limited liability in terms of each other’s actions but not in terms of the business’s debts.
Limited liability partnerships are unique, and not all states allow them. Often, limited liability partnerships include doctor’s offices, law firms, and accounting firms.
For example, Beth, Lynn, and Sara are top-notch attorneys who created a limited liability law firm. However, all three women are responsible for the debts and liabilities of the firm, so if the business runs into trouble, the women’s finances may suffer.
However, if Beth makes an accounting error and overcharges a client, Lynn and Sara will not be accountable for the debt she must pay. Beth is liable for the debt, but the other partners are not responsible for her accidental error.
- Limited Liability Limited Partnership
A new partnership model, limited liability limited partnerships (LLLPs for short), offers more features than just an overly long name.
LLPs are similar in some ways to limited partnerships: a minimum of one general partner oversees and runs the business. However, in this iteration, the general partner’s liability to the company is also limited, meaning that every partner possesses the same liability protection.
LLPs are state-dependent but authorized in over half of U.S. states currently. For example, while California does not permit LLLPs, the state recognizes LLLPs created in other states.
For business owners whose goal is to work in more than one state, LLLPs can be more trouble than they are worth. Additionally, since LLLPs are new to the scene, their attractive debt protections have not yet been vetted in court.
However, many bold entrepreneurs and business owners are taking a risk on an LLLP and finding that, so far, the LLLP format suits them and their businesses. Therefore, our recommendation is to continue following the development of this new partnership until it is more thoroughly tested.
How Are Partnerships Created?
Now that we’ve gone over the basics of partnerships and the different types, the question remains: how are partnerships lawfully formed?
Here are the main steps contractual attorneys take for creating a business partnership for your next big venture.
- Structure the Partnership
Selecting how to structure the business is one of the most important steps to forming a partnership since the structure dictates many other factors.
To choose the most advantageous structure, entrepreneurs should first get together and discuss their goals and the goals for the business. These questions may be helpful to get the conversation going:
- How do the partners envision the finance structure? What about accounting?
- What is the reason for starting the business? Has it always been a lifelong dream, or is it a smaller project or tax shelter? For example, some business partners simply want a steady income and the freedom to run their own company, but others have more significant pursuits.
- Is this a family business; are there other family members who want to be involved?
- During the first year, what do the partners want to get out of the business? Likewise, how much time and funding can they contribute? Then, what is the company’s five-year plan?
Spending time reviewing individual and group goals helps get all of the partners on the same page. These conversations also depend on the number of involved partners since there are additional unique perspectives to consider when more people are involved.
Next, research the types of business partnerships permitted in your state. There are multiple ways to do this, from checking online via the secretary of state’s site to networking with already established businesses. For example, if there is a company that you admire or wish to emulate, reach out to them. While business owners are usually busy, they also enjoy discussing how they got their start and giving advice. Who knows, you might find a valuable business connection.
After researching and speaking with the involved would-be partners about their visions, it is time to choose a partnership structure.
Even when individuals are excited about the new business and certain about their company’s structure, they should not fast-forward through this important step. Once the partnership commits to a structure, it is difficult to change it. Therefore, entrepreneurs should take their time and speak with an experienced attorney about the decision and a tax specialist.
- Create a Partnership Agreement
Partnership agreements are the foundation of every business partnership. They are formal documents that provide details regarding:
- The authority and duties of the partners
- The roles of the partners
- The structure of the partnership
- Sharing of losses and profits
- Important provisions for events such as departures and buyouts
While partnership agreements, just like operating agreements and articles of incorporation, are unique to the business, here are some general points that all agreements cover:
- Are family members part of the partnership, and in what capacity?
- How are profits and losses divided among partners? Is there a distribution schedule?
- What is the process if a partner passes away or wants to depart?
- Is there a provision for buy-sell agreements if a partner wants to buy another partner out?
- How are ownership shares divided?
- How are disputes between partners resolved? What happens if the partners cannot resolve the disagreements?
- If limited partners are involved, what are they responsible for, and what aren’t they responsible for?
- Who manages the company, one partner? More?
- Who are the partners? Include their contact information in the agreement
- Provide the Partnership with a Name
Although naming the partnership appears to be a superficial step, it is more essential than many realize. First, one must ensure that the name is legal in the partnership’s state and that another company does not use it. Here are a few steps that may help entrepreneurs with the process:
- Make sure that the name is available. Sometimes, individuals find that a company they’ve never heard of has used their favorite name for years.
Checking availability can be as easy as looking through the state’s secretary of state website; usually, there is an easy way to find the answer.
- Check the regulations. Each state has different rules about including partners’ names in company names. For example, in California, the business name needs to include the words corporation, incorporated, limited, company, or abbreviation.
Before settling on a name, make sure that the partnership’s name adheres to all state guidelines. This juncture is another excellent time to contact a licensed business lawyer to ensure that the name fits all categories.
- Corporate designators are acronyms such as “LLLP” that display the type of business being formed. States possess different requirements for the inclusion of these designators, so make sure that the chosen name complies.
While these name-related details may appear insignificant, they are an important part of forming a partnership, and the partners should take the process seriously.
Entrepreneurs who create LLLPs, LPs, or LLPs must register the company with their respective states. Here are the quickest ways to do so:
- Select a home state of formation. If the company runs across more than one state, choose the state where the business completes most of its business.
- Ensure that the business has the proper licenses, applying as required.
- Name a registered agent, an individual who will be present in a physical space to accept deliveries of legal notices and additional documents.
- Submit the formal application certificate to the appropriate state offices.
- Maintain copies of all certificates and applications for the company’s records.
- Submit Annual Reports (For LPs, LLPs, and LLLPs only)
Specific partnership structures must submit annual reports to the state to keep them informed regarding the actions of the business. Usually, these reports are due once or twice per year. It is a good idea to schedule these out in advance so as not to forget to submit them, especially when things grow busy.
When Are Attorneys Useful for Business Partnerships?
We hope the details included in this article will help your business thrive. Regardless of the name or structure that you choose, all business partnerships have the potential to be long-lasting and fruitful.
As excited entrepreneurs navigate the process of creating a new partnership, they should have a trusted business attorney with them at every step.
At Nakase Wade, our corporate attorneys and business lawyers understand the challenge of starting a new partnership and the significant rewards. Whether our clients are choosing a business name, debating the best structure, or preparing to register the business, we enjoy being there to answer questions and help strategize how to make the business a profitable, enduring entity.
It takes creative, intelligent, driven entrepreneurs to launch a new venture. Many talented entrepreneurs turn to Nakase Wade in California for our legal business expertise. If you are beginning the process of starting a business partnership or have questions about an existing partnership, do not hesitate to get in touch with us. We offer free initial consultations, so do not wait any longer. Let us answer your questions about the new partnership you’ve set your sights on today.
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