Are you about starting a business and want to use a general partnership entity? If YES, here are 10 pros and cons of forming a general partnership. There are no formalities for a business relationship to become a general partnership. It simply means you don’t have to have anything in writing for a partnership to form.
Even though there are specific requirement for a written partnership agreement, most times it is very advisable to have such a document to avoid internal squabbling (about profits, direction of the company, etc.) and give the partnership solid direction.
10 Disadvantages of Forming a General Partnership
One of the potential drawbacks of a partnership is that the other partners are bound to contracts signed by each other on behalf of the partnership. That is why it is pertinent to only choose partners you can trust, and who are savvy. Here are top disadvantages of forming a general partnership.
Table of Content
- 1. Personal Assets Are At Risk
- 2. General Partners are Seen to Be Agents
- 3. Difficult to Raise Capital
- 4. Taxes from Personal Finances
- 5. Partners are Not Allowed to Transfer Their Interest in The Business
- 6. Exposure to Self – Employment Tax
- 7. Guaranteed Payments are Considered Net Earnings
- 8. Liabilities in a General Partnership are Unlimited
- 9. Some Partnerships Can Be Terminated Even Though the Business is Successful
- 10. Many General Partnerships Suffer from Instability
- 1. Pass – Through Tax Treatments
- 2. Very Easy to Form
- 3. It is a Default Business Entity
- 4. More than One Person Can Be Involved in Fundraising Efforts
- 5. Equal Rights
- 6. Limited Partnerships are Possible in Some Region
- 7. It Allows Multiple People to Come Together to Start a Company
- 8. There Are No Tax Withholding Requirements For Partners
- 9. The Structure Can Be Converted to Other Business Types
- 10. Flexibility
1. Personal Assets Are At Risk
Just like it was stated above, a general partnership does not act as an independent entity. It simply means that every financial protection which partners have in a corporation structure is not found within this structure. A general partnership is more or less similar to a sole proprietorship instead. If there is any problem which affects the finances of the business, then each partner faces a potential personal liability for costs that may be incurred.
2. General Partners are Seen to Be Agents
Have it in mind that every general partner that is part of the organization is considered to be an agent of the partnership relationship. It simply means that if one general partner is representing the company or carrying along with partnership business, then every other partner can be held out as partners when dealing with a third party. It also means that every partner in the structure is liable for the debts that are incurred by the other partners in the course of doing business.
3. Difficult to Raise Capital
Everyone within a general partnership has personal taxation liabilities, coupled with general debt liabilities that fall somewhat outside of their direct control and investors are not really attracted to this type of business. This can make it very hard to find enough money to continue growing outside of the personal networks of the general partners. Howbeit, many general partnerships tend to stay as a small business or eventually restructure into a corporation or LLC.
4. Taxes from Personal Finances
In the State of Washington, for instance, there is no state income tax. Instead there is a business and occupation tax which applies to all businesses. Hence, if your company earns enough revenue during a quarter, you will be asked to pay the state taxes as part of your agreement to do business.
An assumed business name registration is also usually required, plus certain licenses and certifications. However, depending on the type of business formed, a surety bond may also be required. That can put the cost of starting a business upwards of $2,000 for some general partnerships in the state.
5. Partners are Not Allowed to Transfer Their Interest in The Business
Unless clearly stated in a written partnership agreement, a partner is not allowed to transfer or divest themselves of their interest in the business on their own.
Note that if no specific regulations are in place for a transfer to take place, then some states may permit a unanimous vote of the other partners. Have it in mind that it places further pressure on the initial founding of the business, as a single partner may be able to force the issue by filing intent to abandon the partnership instead.
6. Exposure to Self – Employment Tax
In the United States, partners are classified as self – employed individuals when they are performing services for the business. Net earnings include the distributive share of income (or loss) that comes from the business. It simply means that general partners are liable for the self – employment tax in the United States. In 2018, the self – employment tax is 15.3 percent, with 2.9 percent going to the Medicare tax and the remainder going to Social Security.
7. Guaranteed Payments are Considered Net Earnings
Also have it in mind that if a general partner receives a guaranteed payment from the business or partnership agreement, then that income will be regarded as net earnings. In addition, if the business takes a loss, the net earnings could create a tax responsibility for some partners. All net earnings are also subject to the self – employment tax. Until income levels reach $128,400 in 2018, the full amount applies. Above that level, only the Medicare tax applies.
8. Liabilities in a General Partnership are Unlimited
In a general partnership, just like it was stated above, all losses incurred by the business are inseparable from the owners. There is unlimited access to the personal assets of each partner when a creditor makes a claim. The liabilities are also unlimited, and this could force some partners into bankruptcy to preserve some of what they own. Should that occur, the negative credit fallout from such an action could last 7 – 10 years.
9. Some Partnerships Can Be Terminated Even Though the Business is Successful
Always remember that the reason why a general partnership agreement is meant to be in place is that the presence of all partners is necessary for the business to have life. Once a partner decides to leave the business for some reason, or happens to die unexpectedly, then the partnership is terminated without the presence of an agreement. It means the assets would be distributed to the partners and the business would need to restart.
10. Many General Partnerships Suffer from Instability
According to reports, most agreements are formed by verbal commitments and handshakes within the context of a general partnership. It mainly occurs since most people who start a business together already know one another.
When family or friends work together for the first time, there is an expectation of mutual morals and ethics. However, should that alter, these informal agreements, which may be legally binding, can lead to business instability over time. If no legal agreements are in place to settle a dispute, the chaos created can be even more profound.
10 Advantages of Forming a General Partnership
A general partnership is the most basic form of a partnership. Found under common law, it is the definition of an association of people or an unincorporated company.
1. Pass – Through Tax Treatments
Within a general partnership, there is no taxation of the actual business. All income and loss are reported on the personal tax returns of each partner. It simply indicates that partners get to take advantage of the pass – through taxation structure when the company is based in the United States. Also note that all credits and deductions for which the business would qualify transfer over to the personal returns. That can limit the taxation liabilities of the income earned.
2. Very Easy to Form
A general partnership is quite very easy to form, just like a sole proprietorship. Indeed there are fewer formalities involved with their formation when compared to corporations or limited liability partnerships.
A centralized management structure can be formed with a partnership, much like a corporation, or a decentralized structure can be implemented if preferred. Note that the only major document required is a partnership agreement which outlines the responsibilities of each partner to the business.
3. It is a Default Business Entity
Just like a single individual (or a married couple) automatically form a sole proprietorship when establishing a business, a general partnership is more or less seen in the same vein. As long as the partners concur within themselves over the guidelines of the business, there is no legal requirement to draft the details of the business before beginning operations. Also note that most states in the U.S. do not have any required maintenance activities either.
4. More than One Person Can Be Involved in Fundraising Efforts
Unlike a sole proprietorship, the structure of a partnership grants room for multiple people to be engaged in fundraising efforts for the company. Even though fundraising can be quite challenging in this structure due to the personal liabilities involved, having more people active offers more opportunities and room for success. It also leads to improved management techniques within the business, which allows the partnership to benefit from the created efficiencies.
5. Equal Rights
Note that every individual who is part of the initial general partnership when a business is formed under this structure is given an equal right to manage the business. Hence, large partnerships are meant to develop an agreement which outlines each partner’s role within the company. The last thing you want, after all, is to have 4 people all striving to be the CEO whiles nothing else gets done.
6. Limited Partnerships are Possible in Some Region
A limited partnership is allowed within the general partnership structure in some states in the United States. Note that under this structure, there would be one general partner, then at least one limited partner. The general partner is charged with the management of the business. A limited partner contributes assets to the business without a role in how the company is managed.
7. It Allows Multiple People to Come Together to Start a Company
In a general partnership, numerous people from unique backgrounds can come together, pool their resources, and form a business that can grow and generate enough profits. This simply means there can be more diversity within the leadership of a general partnership when compared to other business types. All the experiences and skills can help to establish a successful and efficient business venture in time that has real lasting power for the community.
8. There Are No Tax Withholding Requirements For Partners
Have it in mind that a general partnership may have several people working together at once under the umbrella of the business. Partners, under U.S. law, are not charged for withholding tax payments from one another. This also further simplifies the filing process, even though an Employer Identification Number is often required for this type of business. Only when an employee is hired does the obligation to withhold taxes and send them within the government eyesight.
9. The Structure Can Be Converted to Other Business Types
Without doubts, the liability issue for a general partnership is one of great concern. But unlike a sole proprietorship, a general partner is only 50 percent responsible, at most, for liabilities incurred by the business. If there are 5 partners involved, then the liability percentage drops to 20 percent.
Even then, however, there can be too much risk in this type of structure because there is no personal asset protection. Howbeit, many general partnerships eventually form into an LLC to limit the risks presented by the disadvantages of a partnership structure.
Like limited partnerships and LLCs taxed as a partnership, general partnerships allow you to negotiate the terms relating to allocation of profits and losses, management operations and transfers of interests. It simply means that you can choose who works on which aspects of the business, and can decide on mutually beneficial structures, salaries, payments, and more.
A general partnership is easy to set up, but it is also risky because as a general partner, you and the business are one and the same. However, when you’re first starting a business and have no idea where you’re going with it, a general partnership can be a huge asset. It is always important to get good advice and sit down with a business attorney to help you get started the right way.