There are a number of different ways to organize a business. One of the simplest is to form a general partnership. However, with that simplicity comes one very important characteristic that those considering a general partnership need to know: Forming a general partnership means unlimited personal liability for the partners. That said, it is a very useful way for business start-ups to organize, so it shouldn't be completely dismissed.
What is a general partnership?
A general partnership is the formation of a business between two or more individuals. It can actually be via a written or verbal agreement. It is the simplest and least expensive business structure to form if more than one individual is involved in the business.
The defining characteristic of the general partnership is the fact that the owners of the partnership are all personally liable for legal actions against the partnership, meaning that all debts are personal debts as are any legal judgments. This even extends to innocent partners who can be held responsible if one of the other partners commits an illegal action.
However, there are benefits to a general partnership as the partners all share in the profits and losses generated by the businesses. Further, the general partnership itself doesn't pay taxes as those are paid by the individual partners. This is because the entity is a pass-through entity for tax purposes so any gains or losses are reported by the individual. Not only that, but individual partners must file quarterly estimated taxes on the business income and the partnership still must file a Form 1065 with the IRS.
What's an example of a general partnership?
A general partnership is typically a very early stage business that is started by two or more individuals. Partners simply might choose to start with a general partnership before filing the necessary, and more costly, paperwork to become a corporation.
An example of where a general partnership might be used is in starting a real estate business. For example, if two friends decide that they want to buy and flip a house, they'd likely choose to operate the entity as a general partnership. Both would contribute a portion of the funds needed to acquire and renovate the house, and both might also invest some of their time and talents to build some "sweat equity." Once the renovation project is complete and the house is sold the two friends would record any income or loss on their personal taxes and file all of the other required paperwork.
From there the duo might decide that house flipping is too much work and just dissolve the partnership. Or they could decide that it's a lot of fun and do it again. However, if they do decide to quit their day jobs to take the business to the next level, they would likely then look at forming a limited liability corporation, or LLC. This is so they don't lose their own homes should one of the flips turn into a flop.
A general partnership is one of the simplest business structures for two or more people to form. However, with that simplicity comes one very big risk: unlimited personal liability. As such, a general partnership isn't the best long-term business structure as partners should consider moving to a business structure that limits liability as soon as practical.