One of the biggest decisions an entrepreneur will make is whether to take on a business partner. It might sound simple in the beginning, yet it could turn sour down the road.
This is typically because many entrepreneurs do not weigh the pros and cons of forming a business partnership.
When forming a legal business entity with partner(s), there are three different types of partnerships – limited partnership, limited liability partnership and a general partnership.
In order to understand the benefits and pitfalls to starting a partnership, it’s important to understand the differences between each type of partnership before you sign on the dotted line.
General Partnership: Pros and Cons
The biggest perk to starting a business on your own is that you are the primary person in charge at all times.
However, it can also be your Achilles heel. The simplest business partnership you can form is called a general partnership, when two or more partners form a business and are jointly responsible for running it.
There are quite a few perks that come with general partnerships. For starters, business taxation is flow through. “This means that the general partnership does not pay income taxes directly to the IRS, rather the partnership’s revenue and expenses are included by the partners on their income tax returns. All tax related documents come from each individual owner of the business.”
According to corporate and business attorneys of Strauss & Malk LLP “any losses that the business experiences during this time can be deducted on individual tax returns.”
Most first-time business owners prefer this form of partnership because, when it comes to paperwork, it is much less of a hassle. However, one of the biggest down sides to a general partnership is this: all of the partners are responsible for the liabilities and debts of the company as well as record keeping.
Essentially, general partnerships offer no liability protection to owners. This could really crush your personal finances if not managed appropriately.
Limited Partnership (LP): Pros and Cons
If you’re unwilling to take on 100% liability you may decide a limited partnership is the best entity to form. With this form of business partnership there are limited partners and general partners.
Similar to a general partnership where partners conduct a business jointly, with a LP “one or more of the partners is liable only to the extent of the amount of money that partner has invested. Limited partners do not receive dividends, but enjoy direct access to the flow of income and expenses” (Investopedia).
Yet, if you choose to be a general partner you’ll take 100% liability and play an active role in the management of the company. However, if you are a limited “silent” partner, you do not take on management responsibility, but you also don’t have debt liability.
One of the biggest downfalls to forming a limited partnership is this: if you choose to become a limited partner and you do step into management roles you can easily forfeit liability protection.
Limited Liability Partnership (LLP): Pros and Cons
Limited liability partnerships are the most common types of partnerships in the United States. “The main advantage of an LLP is that all partners are protected by some form of liability protection, but this also means each partner gets a say in how the business is ran” (LegalZoom).
While this is the best option for some, it is not available to all businesses. Only certain types of professional service businesses qualify. Another downside is “the LLP does not shield the partners for liability for their personal acts. Put simply, the LLP cannot limit the liability of owners for their own malpractice,” according to Bizfilings.com.
Choosing the Right Partnership
While partnerships have their distinct pros and cons weigh the decision carefully. Steve Straus, a finance contributor for USA Today suggests, “It’ll be like a marriage if you have a business partner; make sure you’re compatible before you exchange vows.”
Once you sign on the dotted line everything changes. Take time to vet potential business partners before you commit. Work on adhoc projects with your future business partners to ensure you are compatible. If not, and you choose the wrong partner and type of partnership, when the business goes up in flames, you could end up facing the fire alone.
This article has been edited and condensed.
Simon Crompton is an entrepreneur running several online businesses. Currently focusing on his marketing firm, Threecolors.blue, he is also a trained journalist sharing his knowledge via several internet blogs. In his spare time he’s an avid programmer and videographer. Connect with @PermanentStle on Twitter.
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