Partnerships: Basics and Best Practices

What is a partnership?
A partnership can be created automatically when two or more people engage in a business for profit. The Uniform Partnership Act states: “The association of two or more persons to carry on as co-owners of a business for profit forms a partnership, whether or not the persons intend to form a partnership.” This means that the neighbor kid and his friend who run a lemonade stand on the corner of your street technically have formed a partnership.

A partnership can offer owners flexibility and relatively simple organization and operation. While it’s generally not the preferred method for starting a business, knowing some of the basics about a partnership can be a useful tool when starting a new business.

Pros and Cons of Forming a Partnership
Before we dive into best practices for forming and managing your partnership, I wanted to lay out some of the upsides and downsides to forming a partnership. First, partnerships are easy to form and very inexpensive. There are no ongoing formalities, such as annual meetings or filings, and (generally) no minimum taxes, which are generally required for limited liability companies and corporations. Last, partnerships offer favorable taxation as compared to corporations.

Perhaps the single most notable reason why small businesses shy away from forming a partnership is that all partners (or owners) are subject to personal liability for all debts, losses, and liabilities of the partnership. Certain limited partnerships can avoid some of this liability, but a general partnership offers no limited liability to its partners. Due to agency principles, each partner in the partnership is generally liable for every other partners actions on behalf of the partnership. Last, due to the informal nature with which many partnerships are formed, many fail to adequately organize the partnership. Poorly organized partnerships often lead to nasty disputes among partners in the future.

Am I Required to Sign any Legal Documents to Form My Partnership?
No. Partnerships are often formed by a handshake. Oral agreements to form a partnership are also enforceable. Partnerships are the only business entity where this is the case. However, as a matter of best practice, it’s important to document the partnership relationship in writing. Since a partnership is a legal relationship that comes with certain rights and obligations, you can avoid future disputes by clearly memorializing the relationship in a written partnership agreement. Since this is a legal document, it’s best to consult with a qualified business attorney prior to signing any agreement.

Drafting tip: When drafting your partnership agreement you should include certain details about how partnership decisions will be made, how disputes will be resolved, and how the exit will be structured. By addressing these issues in the partnership agreement, you can eliminate many of the hassles down the road related to partner conflicts. Some other important questions to answer in the partnership agreement are: How will the ownership interest be allocated? How will the purchase price be determined for a withdrawing partner? And how will money be paid out to the withdrawing partner?

Managing Your Partnership
Partnerships offer the simplest management structure of any business entity. In a general partnership, every partner (or owner) manages the partnership, and decisions are ultimately decided by a majority of the percentage owners of the partnership. Generally, small business decisions, e.g. ordering staples for the front desk, are made without the need of a vote. Partnerships tend to be managed fairly informally (as compared with other business entities) when it comes to day to day operations. The point at which voting becomes important is when a dispute arises between or among partners. If the dispute can’t be resolved informally, partners generally call a vote on the matter. It’s unfortunate for those partners with a minority percentage of ownership since the majority of percentage owners ultimately decide the vote.

It’s important to note that partnerships do not require any of the formalities required of corporations, such as meetings, records, annual filings, etc. Again, as a matter of best practice, it’s important to hold regular meetings in order to ensure the partnership is running as efficiently and effectively as possible. The informal administration and management structure for partnerships offer a way for individuals to form a business with the ability to later change the structure to a more formal business entity, such as an LLC or corporation.

If you’re interested in forming a business, please check out our business start up package or contact us today to schedule a free consultation.

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