General Partnership Explained: Definition, Formation, Pros & Cons

A general partnership is a legal business arrangement between two or more individuals. The business owners, or partners, agree to share in the responsibilities, assets, profits, and liabilities of a jointly-owned business. Like sole proprietorships, general partnerships are popular business entities due to their ease of establishment and simplified tax structure.

However, just because general partnerships are simple to set up, it doesn’t mean they’re easy or risk-free. Here, we explore what you need to know about general partnerships to help you operate one successfully.

Understanding General Partnerships

In a general partnership, the partners typically share equal responsibility and rights in the business. Unless they have a more specific arrangement, they’ll typically accept 50-50 responsibility of managing the business, contributing capital or services, and sharing in profits and losses. While a formal written partnership agreement isn’t always legally required to form a general partnership, it’s a good idea to get something in writing — especially if each of you will handle different responsibilities or put up different amounts of capital.

Any agreement should outline:

• The rights and responsibilities of each partner.
• How profits and losses will be shared.
• Decision-making processes, including voting rights.
• Procedures for dispute resolution.
• Terms for a partner’s withdrawal, death, or the partnership’s dissolution.

General partnerships offer pass-through taxation, which means the business itself does not pay taxes; instead, profits and losses are passed directly to the partners, who report them on their individual tax returns. That’s one of the key reasons why it’s so important to outline the details of the partnership in writing.

It’s also important to note that general partnerships have unlimited personal liability. Each partner is personally responsible for all business debts and obligations, including those incurred by other partners through the business. If one partner enters into a contract that costs the company money, all partners are liable to pay it. Likewise, if one partner is sued for their actions, all may be found liable. Liability is one of the key reasons why many businesses opt for limited liability companies (LLCs) or corporations.

Advantages of a General Partnership

General partnerships offer several benefits that make them an attractive option for many small businesses:

• Ease of formation: A general partnership is very easy to form, sometimes with as little as a handshake. They’re inexpensive and often require minimal paperwork with the state.
• Simplified taxation: As pass-through entities, general partnerships avoid corporate-level taxes, with profits and losses reported directly on the partners’ personal tax returns.
• Shared management and resources: Partners can combine their skills, expertise, and capital to share the workload and financial burden.
• Flexibility: General partnerships offer flexibility in structuring the business and defining partner roles through the partnership agreement as the business grows.

Disadvantages of a General Partnership

Despite their advantages, general partnerships come with notable drawbacks, as well:

• Unlimited personal liability: The most significant disadvantage is that partners are personally liable for all business debts, obligations, and legal actions. If the business is sued or goes into debt, partners’ personal assets can be at risk.
• Joint and several liability: Each partner is not only liable for their own actions but also for the actions and debts of their partners. Partnerships require a high level of trust.
• Difficulty in fundraising: The inherent unlimited liability can make it challenging to attract outside investors. Any new partners will also inherit debt and liability risks.
• Potential for disputes: Disagreements among partners can be difficult to resolve and may even lead to the dissolution of the business if not properly addressed in the partnership agreement.
• Lack of perpetuity: A general partnership can be terminated by the withdrawal, death, or bankruptcy of a partner, which can disrupt the business.

General Partnerships vs. Other Business Structures

It’s important to differentiate general partnerships from other common business structures:

• Limited Partnership (LP): An LP has at least one general partner with unlimited liability and one or more limited partners whose liability is limited to their investment. Limited partners typically have less involvement in daily management.
• Limited Liability Company (LLC): An LLC provides personal asset protection to its owners while often allowing for pass-through taxation similar to a partnership.
• Corporation: A corporation is a legal entity that is wholly separate from its owners. Business owners have limited liability protection, but may be subject to double taxation due to both corporate income and personal income tax on dividends from the company. However, corporations have access to many potential tax breaks and advantages that could offset the impact of double taxation.