Forming a Partnership

The following article is very informative, it was written by Colleen Debaise, adapted from "The Wall Street Journal Complete Small Business Guidebook" (Three Rivers Press).

When two or more people (not spouses) start a business together, a sole proprietorship isn't an option. Instead, the owners may form a general partnership, which is much like the sole proprietorship in that it can be established easily and requires minimal cost or paperwork (some states might require a basic partnership certificate stating the partners' names, aside from other business licenses). The profits from a partnership flow through to the partners' personal income tax returns. Partners may split profits equally, or decide one or more partners deserve a greater share for contributing either more assets or work hours to the business. Each partner then pays self- employment taxes on his or her share.

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Also like a sole proprietorship, a general partnership doesn't protect against personal liability— and in addition, partners are held responsible for the actions of the other partners. But perhaps the greatest risk with a partnership is the possibility of disagreement and, along with that, disappointment and frustration that can threaten the livelihood of the business. When two or more people start a company together, it's wise (but not legally required) for them to craft a written, carefully thought- out partnership agreement. Much like a prenuptial agreement, the partnership agreement spells out who brings what to the relationship, such as cash or property, and outlines what happens if either partner wants out, dies, becomes disabled or stops performing. Options such as a buyout or sale of the partner's interest should be included in a buy- sell clause or, if complex, in a separate agreement.

Many partners, especially those starting retail or service businesses, will choose to establish a general partnership, although they might also consider forming an LLC or corporation to protect liability, receive different tax treatment or other reasons. In addition, two other but less common partnerships are outlined below.

Limited Partnership

A more formal and complex arrangement than a general partnership, the limited partnership has one or more general partners who make management decisions and one or more limited partners who are passive investors. While the general partners are personally liable for the debts of the venture, the limited partners are liable only to the extent of their investment. An LP may be appropriate for a small but growing business that wants to raise money by selling limited partnership interests in the company.

Limited Liability Partnership

With this vehicle, partners are liable for the company's business debts and for their own negligence, but not the negligence of other partners. The LLP is commonly used by doctors, lawyers and other professionals who want to establish a practice together.