What is a Business Partnership?
Business partnerships aren’t uncommon and, done right, can bring together complementary professionals in pursuit of a common goal. Sometimes, that means bringing together talent and expertise; other times, it’s about pairing an investor with an innovator. In any case, a business partnership is an entity in which two or more individuals or parties agree to operate and manage a business together. This can be between individuals, companies or an individual and a company.
There are significant benefits that come with a well-orchestrated partnership. There are also pitfalls that can accompany a hasty co-mingling. Whether you’re an investor seeking growth prospects or looking to get into business for yourself, it’s important to understand how a partnership works before forming one. Here’s what you need to know.
The Structure of a Business Partnership
Individuals can create or join partnerships. Creation of a partnership occurs when two or more people commit to a business venture and specify ownership stakes. These details take shape in a partnership agreement (see below). Joining a partnership requires an ownership buy-in, usually in the form of investment capital.
Partners receive an ownership stake equivalent to their level of investment in the business. A traditional partnership is a 50-50 split between two people; however, that proportion can range greatly depending on the nature of the agreement. It’s the same for partnerships with three or more ownership stakes.
Because partners are owners, they collect an owners’ draw instead of a regular paycheck. In doing so, they also bear the burden of pass-through taxes. Partners pay personal income taxes in proportion to their share of the profit or loss of the entity. Some partners may also collect additional income—called a guaranteed payment—for active management duties performed on behalf of the company.
Types of Partnerships
Partnerships vary depending on the type of partners involved. Some are active, hands-on and deeply involved with the company. Others are hands-off and passive, and see their ownership stake as an investment vehicle. Here’s a look at the three different types of partnerships, based on the nature of the partners themselves.
What is a General Partnership (GP)?
General partners share management duties equally, as well as profits and losses, regardless of partnership interest. Each partner has unlimited liability, which can become problematic in the event of disagreements between partners. For example, Partner A may assume more fiscal liability than Partner B, while Partner B burdens more operational responsibility than Partner A. The actions of one partner have a direct and proportional impact on other partners.
What is a Limited Partnership (LP)?
Often called passive investors or “silent partners,” limited partners aren’t actively involved in the operation of a company, except in rare instances. They’re also only liable for the amount of capital they contribute within their percentage stake. For example, a limited partner controlling a 10% stake in the company only burdens 10% of total financial liability. Limited partners are more removed from their investment as a result.
What is a Limited Liability Partnership (LLP)?
An LLP protects all parties in a partnership from the actions of all others. It’s a form of limited partnership in that there may be both active and passive partners. While general partnerships and limited partnerships also represent the class of partner, limited liability partnerships represent the legal designation of the agreement. In many ways, LLPs are similar to limited liability companies (LLCs). The chief difference is that in an LLP, only limited partners receive liability protection, as opposed to all members in an LLC.
Understanding Partnership Agreements
Partnership agreements outline the rights, duties and responsibilities of a partner within the context of their relationship to other partners and the business. Some of the items included in a standard partnership agreement include:
- Ownership percentages for each partner
- Rules for the division of profit and loss
- The tenure or length of the partnership
- Decision-making and dispute resolution protocols
- Partner authority (also called binding power)
- Rules for withdrawal from the partnership
- Ownership right in the event of partner death
It’s not uncommon for very small companies and new ventures to be absent from a formal partnership agreement. They’re not legally required; however, they’re used as legal precedent if there’s a disagreement among partners. In the event of turmoil, the Uniform Limited Partnership Act establishes the rights, duties and responsibilities of each partner.
Why do Investors Form Partnerships?
Investors engage in partnerships for many reasons—chief among them are risk mitigation and access to capital. Two people can more easily bear the cost of starting or running a business, and they double the vital resources it has access to. And, when the going gets tough, there are multiple people to mitigate the hit of a loss. There’s less risk involved and much more to gain in working with a partner—even a limited partner.
Two (or More) Heads Are Sometimes Better Than One
Partnerships pool talent, resources, and expertise in pursuit of a common goal. This helps businesses get off the ground faster, at a better trajectory. It also helps spread out and mitigate risk for all parties involved. But a partnership needs to have give and take, and communication is essential.
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Whether general partners or limited partners, cohorts need to be on the same page in terms of mission and decision-making. If they’re not, a business partnership can quickly unravel. The best business partnership is the one that holds strong in the face of growth, setbacks and mission-driven decision making.