A Step-by-Step Guide to Forming a Partnership

Posted by: kevensteinberg
Category: Blog, Business Law
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On the surface, a business partnership may seem like one of the simplest business structures to form in order for two or more individuals to own an entity together. However, there are many potential pitfalls if a partnership is not structured correctly. 

A business partnership requires that you build a strong foundation from the outset. In order to protect your partnership, it is critical that businesses have a strong legal protocol in place through a partnership agreement that guides you on how to address the inevitable challenges and changes that are part of every business life cycle. 

As a business structure, a partnership has many benefits, including more borrowing potential and thus growth capabilities. Having a partner also means you have someone to help bear the burden of debt and decisions. 

However, in order to set up a successful partnership, a business must also prepare for challenges. A strong partnership agreement will help guide the more challenging times. Here’s a guide to understanding the different types of partnerships and establishing one with strong guiding principles. 

3 Types of Business Partnerships

There are three common partnerships: a general partnership (GP), a limited partnership (LP), and a limited liability partnership (LLP). 

A general partnership (GP) is one in which the general partners all have equal ownership and liability. In a general partnership, each general partner is expected to actively participate in managing the business, and any partner may sign a contract on behalf of the partnership. Major decisions, however, must be made together. Since all partners are expected to actively participate in a business, they may also take personal responsibility for the liabilities of the business and for debts incurred by other partners’ decisions. If one partner is sued, all partners may be held liable, and a partners’ personal assets may be seized by the court or a creditor. Due to liability issues, a general partnership is often not the preferred business form. 

A limited partnership (LP) includes a general partner(s) and a limited partner(s). A general partner(s) retains control over the business, and the limited partner(s) receive(s) a portion of the profits but does not maintain control. The partner(s) without limited liability must pay self-employment taxes. Keep in mind that while the limited partner(s) may not have control over the business, they will share in both profits and losses. This means that they may share equally in debt and other liabilities.

A limited liability partnership (LLP) protects each partner from debts and certain liabilities against the partnership so that the individual partners won’t be responsible for the actions of their partners. Limited liability means that the partners’ liabilities are limited to their investments. All partners, therefore, may have limited liability from errors, omissions, negligence, or malpractice committed by other partners or employees. 

Elements of a Strong Partnership Agreement

First, have a written partnership agreement. Whether active participants or passive investors, it’s important that partners clearly outline their relationship, shares, and types of ownership and duties. Having this document to refer back to will guide where to begin and hopefully help resolve disputes. It will also put in place safeguards if the partnership must be terminated. 

Some important elements to consider when creating a partnership agreement include different partners’ obligations in regard to the following: 

  1. Ownership
  2. Authority
  3. Contribution 
  4. Workload
  5. Compensation
  6. Dispute Resolution
  7. Death/Succession
  8. Exit Clauses

The other critical part of having a strong partnership agreement is to secure advance guidance and advice. A well-versed business attorney will be able to serve as a guide during setup and a mediator during disputes. An objective third-party will help the partners put emotions aside and focus on solutions, not the problem. An experienced attorney also has a depth of knowledge upon which to draw to help solve disputes or suggest effective strategies or solutions. 

Additionally, an attorney can recognize if a dispute cannot be resolved and if the partners are better off with an amicable separation. Businesses change and so do visions for the future. If this is the case, a termination may be the best solution. However, terminating the partnership may be complicated, and getting help sooner rather than later is critical. An attorney can help you understand your rights and responsibilities and will be critical if it becomes necessary to protect your business interests.

Overall, it’s important to prepare for not if, but when conflicts arise. In order to do so, your business should have procedures in place to deal with conflict and secure your business interests. It is absolutely critical that if your partnership cannot be salvaged, you have an attorney by your side. If you are proactive before conflicts arise, your business can often mitigate damage, and it will likely be easier to resolve issues or terminate the partnership in an orderly fashion.

Be Prepared from the Beginning to the End

With these structural foundations, what structural elements do partnerships need to keep in mind? The California Secretary of State advises that before forming a partnership, all business owners consult with an attorney to understand binding legal obligations and to accurately set forth a business plan. Each type of partnership is set up differently, and each state has different requirements. Here are the pieces that are necessary to understand when setting up a business in the state of California. 

  1. File with the Secretary of State. Here are each of the forms for each type of partnership: 
  2. While it may seem counterintuitive to plan for the end from the beginning, it’s a critical part of the process of establishing your business. Dissolution looks different for each type of partnership.

The California Revised Uniform Partnership Act (RUPA) dictates the legal standards and obligations for partnership dissolution.

Here are the steps to take to dissolve a partnership in the state of California: 

  1. Review the partnership agreement 
  2. Vote or take action to dissolve
  3. Pay remaining debts and distribute remaining assets
  4. File a dissolution form with the state
  5. Notify concerned parties
  6. Resolve remaining tax issues (file and pay final current year tax return)
  7. Complete any out-of-state regulations and pay any taxes if registered in other states

Enable a Powerful Partnership with a Business Attorney

Partnering is powerful because the whole is worth more than the sum of the parts. However, a partnership can also be dangerous if not set up correctly or entered into with clear procedures and guidelines. To not have a strong agreement is to take risk of losing not only your business but also potentially investors’ personal assets. Planning and communication are the solutions so that decisions can be made before the stress of the moment arises and emotions become involved.

If you’re forming a partnership, make sure to have an experienced business attorney by your side. Contact us at Steinberg Law for legal advice to empower your next business venture.

Author: kevensteinberg