Business Structures - Partnerships

By: Mike Gallagher, District Director
North Dakota District Office

The series continues with a look at the most common type of partnership, the general partnership. We’ll be looking at six important factors: complexity, liability, number of owners, capital, taxation and survivorship.

Complexity
General partnerships can be very simple to set up. If the business name doesn’t disclose the actual names of the partners, you’ll need to register the trade name. The registration forms can be found on the ND Secretary of State website. The cost is $25 for a basic 5-year registration.

General partnerships don’t have to be in writing to be a legal partnership. You can have an oral, “handshake deal”. But you should ask yourself, what happens to my interest in the business if I die? What if I need to move out of state? What if this doesn’t work out? What if . . . ? In other words, it is best to evaluate what your (and your partner’s) goals are before you go into business together. The expectations may not be the same. By putting together a written partnership agreement before entering into the partnership you establish the basis for the relationship, while everyone is thinking you are going to make a million dollars in a year and getting along great. About the time the bills come in and there is not enough money to pay them all, or one partner is not doing enough to bring in sales, or . . . basically, if problems start to develop in the relationship, how likely is it that the parties can agree on anything? Decide at the beginning how to resolve some of those issues and put it in a written agreement. This is especially important when you look at the next factor.

Liability
The liability exposure for each partner is the same as a sole proprietorship  - unlimited personal liability for everything the business does. This means if your partner purchases a new, fancy pickup truck and takes out a loan for the truck in the business name, either or both partners are responsible for payment even though one partner may not feel it is needed and never gets any value from the truck.  Each partner is 100% personally responsible for payment. You may be able to collect it from your partner based upon your agreement, but don’t count on it. It is extremely important that you know your partners very well and can trust them to make good decisions for the business.

Number of Owners
A general partnership requires two people or more. However, in a general partnership the partners share control of the business. The more partners involved in the business, the more difficult the decision making process can become.  A written partnership agreement is important if you want to establish written limits to how the partners exercise this share in the control.

Capital
The ability to raise capital is similar to the sole proprietorship. It is limited to each partner’s personal net worth and good name. To raise more money you have to add partners.

A written partnership agreement would be important if you wanted to detail an understanding of how much and what type of capital will be offered to the partnership. If one partner is offering assets such as tools or equipment to the partnership, the agreement could spell out what these assets are and establish a value.

Draws from the partnership are a reduction in the capital provided by individual partners.  Partners do not get a “wage” or “salary”. Any money they take out of the business in the form of cash or other assets is a draw or reduction in the capital basis. Detailing how much each partner can draw from the business would be another important element to include in the partnership agreement.

Taxation
A general partnership files an informational tax return listing the sales, expenses and taxable income or losses. It then issues a K-1 statement to each of the partners, dividing the taxable income or losses between them in proportion to their ownership interest.   Ownership interests and profit and losses do not always have to be shared 50 – 50.  A written partnership agreement would spell this out.  The partners must include that income or loss on their personal tax return and pay the taxes due or receive the benefit of the losses against personal income. Forms can be found on the IRS website.

Survivorship
A general partnership “dissolves” on the death of a partner. It does not have to “terminate” or liquidate and start over, but legally it becomes a different general partnership. The deceased partner’s interest may pass to the heirs or to the other partners depending on the agreement.  A partnership agreement should detail what happens to the partnership interest in the event of the death of one partner.  It might provide detail on how the partnership interests are valued and offer a method, such as life insurance, to fund the purchase of the partnership interests by other partners.

Finally, there is another type of partner that most people call a “silent partner”. This is a slightly different partnership form. Most of the factors described above remain the same. The main difference is you must have at least one partner that is a general partner and 100% liable for the business operations, and at least one partner that is limited, or silent partner that has no liability. Of course everyone wants to be the limited partner. However, the catch is the silent part. The limited partner cannot exercise any control over the decisions made in the operation of the business. If the limited partner participates in control, they will also become liable for the business operations.

The next article will evaluate the options for corporations.


Mike GallagherMike Gallagher joined the U.S. Small Business Administration in 1984 as a Business Development Specialist.  He was chosen as the Deputy District Director in 2005 and the District Director in November 2013.  A graduate of the University of North Dakota, Mike is a Certified Public Accountant and a former business owner.  He can be reached at michael.gallagher@sba.gov.

 

Other Business Structure Articles from the North Dakota District Office

How Do I Choose a Business Structure?

Pros and Cons of Sole Proprietorships