Updated: Jul 9, 2020
This post should not be relied upon as legal advice.
Today we continue our series on business organizations and look at partnerships. A partnership is a separate legal entity created by two or more individuals (“partners”) who each contribute capital, equipment, and skills and share in profits and losses. Partnerships come in two forms: 1) general partnership and 2) limited partnership. Today we focus on general partnerships.
General partnerships are the simplest form of the two partnership types, requiring no legal agreement or filing with the state to create. A general partnership is a separate legal entity that can contract in its own name, title assets in its own name, and can be sued. Similar to a sole proprietorship, the liability in a general partnership is not limited to just the business assets; your personal assets are potentially liable for legal claims against the business and other partners. If asset protection is your key goal, then a general partnership may not be for you.
Ease of formation is why many individuals utilize general partnerships. In many cases, all we need to see to find a general partnership is profit sharing. For example, Bob and Charlie are father and son and also farm together. Charlie and Bob share in management and labor decisions and each year split the profits. Even though there is no formal written agreement between Bob and Charlie, they have effectively created a general partnership. But an agreement between the parties formalizing the partnership should always be considered.
With a general partnership, each partner is a co-owner in the business and each partner is jointly and severally liable for the business actions of the other partners. Looking back at the Bob and Charlie example, if Bob goes to the local tractor dealership and purchases a new tractor for the partnership without consulting Charlie, both parties would be liable for the tractor since this was a business action.
General partnerships have some similarities with a sole proprietorship. Partners are taxed on profits and the partnership is not taxed, similar to a sole proprietorship. Also the general partnership would dissolve when one partner dies or becomes incapacitated. This is similar to a sole proprietorship dissolving upon the death of the owner. Finally, capital for the business is limited to what can be borrowed or personal assets of the partners, much like it was for a sole proprietorship. New partners can be added, but this effectively creates a new partnership every time partners are added.
General partnerships are also as easy to dissolve as they are to create: the partners can just decide to walk away and split up partnership assets. Another reason partners should consider a written partnership agreement is to spell out how assets will be distributed when the partnership is dissolved.
As you are beginning to see, not all business organization structures are created equally. Some offer little to no protection to shield your personal assets from business liabilities. Sole proprietorships and general partnerships are two of the very basic structures offering limited protections. As we continue on you will see the potential benefits of other types of business organization structures. Remember, before deciding one structure is perfect for your farm, talk with your attorney and tax preparer to understand how switching a certain business organization structure could impact your individual situation. We are just giving you broad overviews of each structure, while those professionals can help you understand how it will impact your personal situation.