Launching a business with a partner can be an effective way to combine skills and resources. A general partnership offers a straightforward path to co-ownership for two or more individuals pursuing a shared business goal. The process involves several considerations, from internal agreements to external registrations, that set the foundation for the enterprise.
What is a General Partnership?
A general partnership is a business structure where two or more individuals co-own a business and agree to share in its assets, profits, and liabilities. It is one of the simplest business entities for multiple owners, often compared to a sole proprietorship with more than one person involved. In most states, a general partnership can be formed through a simple verbal agreement, with no formal state filing required to begin operations. This ease of formation makes it an accessible option for entrepreneurs.
A defining characteristic of this business type is unlimited personal liability. This means that the partners are personally responsible for all business debts and legal obligations. If the business incurs a debt or is sued, a partner’s personal assets could be used to satisfy the obligation. This liability is shared, meaning one partner can be held responsible for a debt incurred by another partner on behalf of the business.
Another aspect is pass-through taxation. The partnership itself does not pay income tax. Instead, the profits and losses of the business are “passed through” to the individual partners. Each partner then reports their share of the income or loss on their personal tax returns and pays taxes at their individual rate. This avoids the double taxation that can occur in corporations.
Create a Partnership Agreement
While not always legally required, a written partnership agreement is a document that prevents future conflicts. This internal contract outlines the rights, responsibilities, and expectations of each partner. A comprehensive agreement provides a clear framework for operations and decision-making, ensuring all partners are aligned from the start.
Capital Contributions
The agreement should detail the capital contributions of each partner, including money, property, or other assets. Documenting the value of these contributions is important, as this often influences ownership percentages and profit distribution. The document should also outline a process for how partners can make additional contributions.
Roles and Responsibilities
Defining the roles and responsibilities of each partner helps ensure smooth day-to-day operations. This part of the agreement specifies who is responsible for tasks like sales, marketing, finance, or operations. Assigning specific duties helps the partnership avoid confusion and prevent duplication of effort.
Profit and Loss Distribution
The partnership agreement must address how profits and losses will be divided. The distribution does not have to be an equal split and can be allocated based on capital contributions, time invested, or other factors. Establishing these terms in writing ensures transparency and should state the formula used to calculate each partner’s share.
Decision-Making and Dispute Resolution
The partnership agreement should establish a process for how major decisions will be made, such as requiring a unanimous vote or a simple majority. It should also include a dispute resolution clause outlining the steps for when partners cannot agree. This could involve mediation or another method to resolve conflicts without resorting to costly litigation.
Partner Withdrawal or Death
The agreement needs to detail the procedures for when a partner withdraws from the business or in the event of a partner’s death. This section includes buyout terms, specifying how the departing partner’s share will be valued and purchased by the remaining partners. This planning ensures the business can continue operating smoothly during an ownership transition.
Register Your Business
After creating a partnership agreement, you must register the business. If using a name different from the partners’ legal surnames, you will likely need to file a “Doing Business As” (DBA) or fictitious name. This registration informs the public that the business is operating under an assumed name and is typically filed with the county or state.
Obtaining a federal Employer Identification Number (EIN) from the Internal Revenue Service (IRS) is a key step in formalizing the business. An EIN is a unique nine-digit number that functions like a Social Security number for the business. It is required if the partnership plans to hire employees or file an annual partnership tax return.
Applying for an EIN is straightforward and can be completed online through the IRS website at no cost. This number is needed for many of the financial activities that follow the formation of the business. The EIN solidifies the partnership as a distinct entity in the eyes of federal tax authorities.
Obtain Necessary Licenses and Permits
After registering the business name and securing a tax ID, the partnership must obtain the proper licenses and permits to operate legally. These requirements vary significantly based on the industry and geographic location of the business. Operations may be subject to regulations at the city, county, and state levels, so you must research the rules applicable to your venture.
For example, a restaurant will have different licensing needs, such as health permits, than a consulting firm. To identify the required licenses, partners can consult local government websites and the local chamber of commerce for municipal and county-level requirements. The U.S. Small Business Administration (SBA) website also offers guides for navigating federal and state-level compliance.
Manage Partnership Finances
With the legal foundations in place, the focus should shift to managing the partnership’s finances. A primary rule is to maintain a strict separation between business and personal funds. Commingling finances can create accounting confusion and potential legal issues, so establishing this separation from day one is standard practice.
The most effective way to separate finances is by opening a dedicated business bank account. This account should be opened under the partnership’s registered name using its EIN. All business income should be deposited into this account, and all business expenses should be paid from it. This creates a clear financial record for the partnership.
Alongside a business bank account, setting up a basic bookkeeping or accounting system is necessary. This system will be used to track all income and expenses, which is needed for managing cash flow, making business decisions, and preparing tax filings. Consistent financial tracking ensures the partnership remains financially organized and compliant.