Shawn has a masters of public administration, JD, and a BA in political science.
What Is a Partnership?
Let's first understand what a partnership is. When two or more parties come together and agree to cooperate in advancing their business interests, they form a type of business called partnership. The parties are considered the owners of the partnership business, or the partners, and they share the profits, losses if they occur, and also the risks involved.
The information about how the partnership business is operated and the particulars of the agreement between the parties are included in a document called the partnership deed or partnership agreement. The partnership agreement is a legal document, signed by all the parties in the partnership, and it details the roles, duties, rights, and responsibilities of the partners, as well as how the profits and losses should be distributed among them.
Let's now look at the different types of partnerships including general partnership, limited partnership, limited liability partnership, and limited liability limited partnership.
Meet Gail and Patrick. Both are attorneys who decide to start a law firm together. They decide to form a general partnership. A general partnership exists when two or more people own a business. Gail and Patrick write a partnership agreement that outlines such things as:
- The scope of the partnership's business
- The percentage of the business each partner owns
- How profits and losses will be allocated
- How the partnership will be managed
- Whether new partners can join
- Selling or transfer of partnership ownership interest
- Termination of the partnership
A general partnership gives the partners some important advantages. Gail and Patrick have a great deal of flexibility in the design of their partnership. They don't have to deal with a bunch of complex laws and regulations that apply to other business organizations, like a corporation. Partnerships are generally not subject to federal income taxation. Instead, all the profits (or losses) are passed through the partnership to Gail and Patrick, who will report the income (or loss) on their personal tax returns.
The biggest disadvantage of a general partnership for Gail and Patrick is personal liability. Gail and Patrick will be personally liable for the debts and obligations of their partnership. Creditors can pursue their personal assets to collect on partnership debt. If someone is injured by the partnership and wins a court judgment, the plaintiff can pursue Gail's and Patrick's personal assets to satisfy the judgment.
Meet Lilly and Patrica. Lilly is a gourmet baker and Patrica is her wealthy friend. Lilly comes to Patrica about going into business together. Lilly wants to start a gourmet cookie company but doesn't have the start-up capital. Patrica doesn't know anything about baking, but she sees a great investment opportunity after hearing Lilly's pitch. They decide to form a limited partnership (often called an LP) and compose a partnership agreement. They'll have to register their new LP with the secretary of state in the state where it is located.
Lilly is the general partner and Patrica is the limited partner. A general partner manages the partnership and is personally liable for the partnership's debts and other legal obligations. Since Patrica is a limited partner, she does not have the right to manage the limited partnership, but she is not personally liable for the partnership's legal obligation. Patrica, unlike Lilly, can only lose her investment in the limited partnership and nothing more. You can think of a limited liability as a sort of shield that protects you from liability.
Limited Liability Partnership
Meet Larry, Linda, and Polly. They are three accountants that have decided to form an accounting firm together and opt to organize a limited liability partnership. In order to form the limited liability partnership (LLP), Larry, Linda, and Polly must register their business with their state's secretary of state. Some states will only let certain professionals, like lawyers and accountants, form LLPs.
An LLP provides a significant advantage for Linda, Larry, and Polly over a general partnership. Unlike a general partnership or limited partnership, an LLP provides all partners a degree of limited liability. Some states only provide a partial shield from liability, while others provide a full shield from liability. In partial-shield liability, partners are only free from personal liability caused by the wrongful or negligent acts of the other partners. In a full-shield liability, partners are fully protected from obligations arising from wrongful and negligent acts of their partners as well as contractual obligations. In other words, under full-shield protection, Larry, Linda, and Polly only risk their investment in their accounting firm; they are not personally liable beyond their investment. It's important to note, however, that since Larry, Linda, and Polly are professional accountants, each is still personally liable for their own acts of professional negligence or malpractice.
Limited Liability Limited Partnership
Meet Linus, Laura, Leanne, and Paul. They want to form a real estate development company to flip houses. They decide to start a limited liability limited partnership for their new company, often called an LLLP. Not all states permit an LLLP, but some do. Linus, Laura, Leanne, and Paul will have to register their business with their secretary of state for their state. Linus and Laura will be the general partners and will do most of the work. Leanne and Paul are limited partners who provide most of the financing. The main difference between an LLLP and a limited partnership is that a general partner is not personally liable for the negligence or wrongdoing of another general partner. So if Linus messes up, Laura is not personally responsible for his negligence. Limited parties like Leanne and Paul are not liable for partnership obligations except to the extent of their investment.
Dissolution of a Partnership
If a partnership cannot exist any longer, it can be dissolved or the partnership agreement terminated. This can take place when one of the partners withdraws from the partnership, one of the partners dies, the partnership is declared bankrupt, or even when it is declared illegal. Once the partnership is terminated, a dissolution of a partnership deed is prepared to detail the terms under which the business is terminated.
Let's review what we've learned. All partnerships are business organizations consisting of at least two owners. Partners enter into a partnership agreement, which outlines the roles, duties, rights, and responsibilities of the partners. Partnerships do not generally pay income taxes at the entity level. Instead, income and losses pass through the partnership to each partner, where they report their share of income or loss on their personal tax returns.
While all partnerships generally have the characteristics we just discussed, there are some differences between different types of partnerships. A general partnership offers no limited liability for its partners, and partners are personally liable for the negligent or wrongful conduct of the partnership as well as debts and contractual obligations.
In a limited partnership, the general partner manages the partnership and limited partners do not. However, while general partners have personal liability, limited partners do not. Limited liability partnerships offer either full or partial protection from personal liability for all partners. Limited liability limited partnerships are like limited partnerships except that general partners are not personally liable for the negligent or wrongful conduct of other general partners that are related to the business.
A partnership business can cease to exist or be terminated when a partner withdraws, dies, the business becomes bankrupt, or when it is declared illegal. Dissolution of a partnership deed is prepared in such a case stating the terms of dissolution.
After watching this lesson, you should be able to differentiate between the types of partnerships and discuss the advantages and disadvantages of each.
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