Operating Your Business as a Partnership – The Pros and Cons

Editor's note: Lisa Lehman is off this week, so we are sharing one of her columns from early 2011. Enjoy!

My friend and I are starting a new business that we will both operate. We will equally share the profits. I think we should be a partnership, but am not sure.  What are the advantages and disadvantages of operating our business as a partnership?  — Jim

Dear Jim,

You didn’t mention the type of business you and your friend are starting. That will often impact the decision as to whether you should operate as a partnership, or some other type of business entity.  

Today, I will only discuss the pros and cons of forming a partnership. In future columns, I will write about other types of business entities available to you and your friend, such as the corporation and the limited liability company.  

As with other business considerations, partnerships can be a good or bad thing depending on the parties and circumstances involved. First, you should understand there are two types of partnerships – a General Partnership and a Limited Partnership. In both types of partnerships, two or more people go into business together with the intention of making a profit. To make this a little easier to read, I will refer to a General Partnership as a “GP” and a Limited Partnership as an “LP."

In the LP at least one of the partners is simply a “passive investor” and doesn’t get involved in the business operations. This passive investor is called the “Limited Partner.” While the Limited Partner doesn't become active in the business, he or she is only legally liable for debts or other financial obligations of the partnership to extent of his or her financial contribution to the partnership. This is known as “limited liability.”  For example, if a Limited Partner invested $10,000 in an LP and the LP was sued, that Limited Partner would be responsible for no more than the original $10,000 investment.

In a GP all partners are “General Partners” and are actively involved in running the business. But here’s the bad news. General Partners are personally responsible for all of the GP’s debts and financial commitments.

So, if someone filed a law suit against the GP and prevailed, the General Partners would have to pay that person in full. If the GP did not have enough money to pay the creditor, the personal assets of the General Partners (home, investment accounts, etc.) would be used to do so. This is because General Partners have what is known as “unlimited liability.”

Since you and your friend will both be involved in operating the new business, you would be a GP and all of your personal assets would be at risk if the business got into financial trouble. Obviously, this is one significant disadvantage of conducting business as a GP.

Another big “con” with a GP is that all General Partners are jointly and severally liable. This means that if your partner doesn’t have any personal assets (or takes off to Mexico!), the creditor could collect 100% from your personal assets.

Finally, remember now you are in business with someone else and you can’t call all of the shots. So you lose some control. Decision-making is shared, and you and your friend may have disagreements.

Too often I have seen friendships ruined when friends went into business together. Bear in mind John D. Rockefeller's famous words:  "A friendship founded on business is a good deal better than a business founded on friendship."  This is why it is so important to have a written partnership agreement spelling out the rights and duties of each partner.

But it’s not all bad news. There are advantages to operating as a GP. For one thing, start-up costs will be shared, lessening the impact on your wallet. You and your friend will also share the responsibilities and work.

Each of you may have complementary skills and talents that will allow your business to prosper better than it would if you went into business by yourself. Also, you and your friend will lend mutual support and motivation to each other, which can be very important for a fledgling business.   

The most important “take-away” from this column is my advice to get your deal down in writing so that each of you knows what is expected of the other. This could save your friendship and keep you out of Court.  I wish you all the best in your new business endeavor!

If you would like to ask me a legal question, post it on the Lake Zurich Patch website or send your question to me at lehmanlawoffices@aol.com.

     Please be aware that this column provides only legal advice of a general nature. You should always consult with an attorney with respect to your particular legal situation.

Lisa