Why is a General Partnership a Horrible Structure for Small Business Ownership?

If you are thinking about starting a new business with one or more business partners, you have a variety of choices in terms of selecting a legal structure for the business.

A partnership is the simplest and perhaps the oldest type of business structure. In fact, it is so easy to create (e.g., there is no required filing with the State Corporation Commission) that many small business owners create them without even realizing it. Basically, any business conducted by two or more people with the intent of generating profit is considered a general partnership under the law. Simple, yes. A smart idea, no. The problem with partnerships is that both you and your partner(s) are each PERSONALLY obligated for ALL debts and liabilities of the business. YIKES! Personal liability exposure is not a good thing and should be avoided whenever possible.

In a general partnership, each partner has an equal vote and will share in business profits and losses on a pro rata basis in accordance with their respective contributions of cash and property to the partnership (unless the partners agree otherwise in writing). Each partner has the authority to act as an agent of the partnership and bind the partnership to contracts with third parties.

General partnerships can be formed by operation of law without the parties intending to do so. The number one thing a court will examine when deciding if a partnership exists is the sharing of profits between two or more people. Oddly enough, this is not always an easy determination to make.

For example, most businesses require some amount of startup capital. When a person invests money in a business, he or she does not automatically become a partner; the surrounding facts and circumstances must be considered. Perhaps the intent was to make a loan to the business which would be repaid out of the profits of the business. However, if the parties intend that the profits will continue to be shared even after the loan has been fully repaid, then the “lender” may actually be a partner under applicable law. Courts will also look to other relevant facts and circumstances such as: (i) sharing in profits and losses of the business; (ii) active involvement or control over the purpose of the business and its day-to-day activities; and (iii) the intent of the parties.

So why would anyone intentionally conduct business through a general partnership? Good question! Don’t find yourself in an accidental partnership and risk financial ruin from personal liability exposure from anything and everything that can go wrong over the life of a small business. Reach out to Perkins Law to discuss structuring your new small business through a legal entity such as a limited liability company (LLC) or corporation. You (and your family) will be glad you did.