Partnerships are also a relatively common way for people to go into business on their own. In most states, if you decide to create a business that you and one or more other people own, that business will have the form of a partnership unless you take particular steps to do otherwise.
As a result, partnerships are also generally simple to form. The one wrinkle, though, is that unlike sole proprietorships, in which only a single owner is present to take all profits, a partnership necessarily involves two or more people. Therefore, the partners have to agree about how they will split the costs of doing business and the revenue generated from their activities. Ideally, partners should put these agreements in writing, since they can become extremely complicated. In situations in which the partners have only an oral agreement, or a short written agreement that doesn't address a problem that comes up, states usually have laws that establish some limited default provisions.
The primary advantage of a partnership is flexibility. The partners have almost unlimited discretion to delegate particular tasks and responsibilities among themselves. Therefore, it's common to see partnerships in which one partner contributes a significant amount of start-up capital but does little work, while another partner makes almost no initial contribution of capital but spends a lot of time working hard to establish the business. There are few limits on how partners can structure their agreements among themselves. In addition, partnerships are usually not taxed at the entity level. Instead, the income is treated as belonging directly to the various partners, who are then taxed accordingly. Even though the partnership rarely owes tax itself, it must file a tax return to report the income allocable to the various partners.
The downside of partnerships is the same lack of liability protection that sole proprietorships face. Indeed, in the case of partnerships, this is an even bigger problem, because often each partner can be jointly and severally liable for the liabilities of the partnership. This means that if your partner does something wrong, your own personal assets may be at risk, even though you weren't the one at fault.
Partly because of this liability problem, there are other forms of partnerships. A limited partnership usually has two types of owners: general partners and limited partners. Limited partners typically make a simple investment into the partnership. Although they can lose the entire amount of their investments, the limited partnership shields them from any additional losses. General partners, on the other hand, still face potentially unlimited liability.
Although most partnerships are privately owned, some are publicly traded. For instance, Kinder Morgan Energy Partners (NYSE: KMP ) is a limited partnership whose general partner is Kinder Morgan (NYSE: KMI ) , and whose limited partnership units trade in the same way that corporate shares trade on the New York Stock Exchange.
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Fool contributor Dan Caplinger welcomes your comments.