When two or more people agree to share profits and losses, a partnership has been formed. The business may have as many partners as agreed upon, with nothing more than a handshake or an oral agreement. In fact, state law provides that under such circumstances you have formed a General Partnership, and no formal Partnership Agreement is required by law. Like a Sole Proprietor, the partners simply obtain a business license and a sales tax number where required, then comply with any other State regulations, and they are in business. For many partners this sounds like a blessing, but in reality it can cause some serious legal and financial problems.
Disadvantages of a General Partnership
The number one disadvantage of a General Partnership is that each partner is liable for the debts and obligations incurred by all the other general partners. Consider the following points:
- You may trust your partner(s) not to improperly obligate the business; nevertheless, unpredictable situations can arise.
- Also, the more general partners you bring into the business, the greater risk you run that someone will eventually make a serious error.
- The result is every partner’s personal assets are at risk. Even if you had absolutely no connection with the actions of another partner, you are still personally responsible for the decisions made and actions taken. Your personal assets and life savings can be lost through the actions of your partner.
In a General Partnership, any general partner may obligate the business. As you can see, when operating as a General Partnership you are actually using a far less desirable entity for conducting business than a Sole Proprietorship. In contrast, Limited Liability Companies and Corporations offer much greater protection. Both offer the owners the limited personal liability for business debts and the acts of others.
Cost Factors to Consider
One last factor to consider is cost. An attorney will typically charge between $2,000 and $5,000 to write a General Partnership Agreement because each one must be custom tailored to address the specifics of each business. That is a significant amount of money for an entity document that will not protect the owners from personal liability. Generally, attorneys will strongly recommend an LLC or Corporation, which will better protect their clients at far less cost. After all, why pay more to be put at greater risk?
Every business is unique. In the final analysis, what may be advantageous to one person may be disadvantageous to someone else. However, because significant tax and legal repercussions flow from your decision to conduct your business as a sole proprietorship or general partnership, you should be aware of them. Of course, by being aware, you can best avoid unexpected and unintended consequences.
At Advantage Delaware LLC we form Delaware corporations and LLCs daily for businesses across the country and around the world. We invite you to learn more about the advantages of forming a corporation or LLC in Delaware, or get in touch with our team if you’re considering incorporating a business.
