Business Partnership Definition: Types, Advantages, and How to Start One

A business partnership can be a great way to get your company off the ground in the US, with the support of other key stakeholders who also contribute time, capital and expertise. There are several different types of business partnerships which means you can easily pick the right one for your specific needs. As a partnership business, your company and personal finances may be considered as one for tax purposes - which is a simple structure, but does carry risk.

This guide walks through some of the advantages and disadvantages of business partnerships, and also looks at how to form a business partnership in the US.

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Business structure types

Understanding the different types of business structure open to you is crucial, to make sure you pick the one which best matches your own specific needs and ambitions.

The most common forms of business in the US are¹:

• Sole proprietorship
• Partnership
• Corporation
• S corporation
• Limited liability company (LLC)

Each different option has its own features and benefits - and importantly, can lead to different legal and tax obligations on the owner. If you’re thinking about partnership as an option this guide is for you - we’ll cover the key question: what is a business partnership? Plus, we’ll look at why and how to form one.

Business Partnership Definition

Let’s start with the definition of a business partnership, courtesy of the Internal Revenue Service (IRS)²:

A partnership is the relationship between two or more people to do trade or business. Each person contributes money, property, labor or skill, and shares in the profits and losses of the business.

There are various different types of partnership which we’ll explore throughout this guide. However, some of the key characteristics of a partnership can include:

• A partnership is a business owned by two or more people - several different partnership models are commonly used in the US
• Each business partner is expected to contribute towards the business - for example, with capital or time
• A business partnership agreement which can be oral or written should govern the agreement between the parties
• Businesses that are partnerships must file income reports to the IRS - but do not pay income tax as a business
• Partners must report their own business income and losses, in their personal tax return. This is known as pass-through taxation

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Types of Business Partnerships

While the definition of partnership in business is pretty straightforward, there are several different partnership types - which can mean you need to do some thinking before you decide which to pick out. Here’s an overview of the common business partnership types used in the US.

1. General Partnership (GP)

General partnerships are formed when two or more parties agree to work together, with the details of the partnership being captured in a partnership agreement. All parties share the business risks and rewards equally - meaning that each partner is equally liable for any debts or legal issues with the business, and also entitled to an equal share of any profits generated.

Key Points:

• All partners share legal and financial risk on an equal basis
• Profits should be distributed equally among partners
• A written partnership agreement should govern the way the partnership works, including profit sharing and an expulsion clause
• In many US states, the Uniform Partnership Act (UPA) sets out the model to be used for partnership formation and dissolution

2. Limited Partnership (LP)

A limited partnership is formed of at least one general partner, and at least one silent partner. The general partner (or partners) takes responsibility for the business, including full legal and financial responsibility. Silent partners are not as involved in the business and their liability is limited to only the amount they invested in the first place. This means that if the business accrues debts, they can only lose the amount they invested, while the general partner would bear any costs in excess of the amount initially staked in the business.

Key Points:

• Must include at least one general partner and at least one silent partner
• General partners take full legal and financial responsibility for the business
• Silent partners are only liable up to the value of their initial investment
• Silent partners may not qualify for pass-through taxation - this depends on the state you’re in
• Some states also offer a variant on this model - the Limited Liability Limited Partnership (LLLP). Here the general partner may also qualify for some limited liability, but this entity type is not universally available or recognised

3. Limited Liability Partnership (LLP)

In a limited liability partnership, the liability of each partner is limited, so that if one partner accrues debt or runs into legal issues themselves, the other partners are not automatically liable. This form of partnership is commonly used among professionals working together, such as lawyers or accountants, and protects the group against the actions of any individual member of the partnership.

Key Points:

• Individual partners’ liability is limited to protect them against issues caused by other partners
• Frequently used by professionals working in partnerships, who each hold responsibility for discreet projects or customers
• LLPs are not available in all states
• In states which follow the UPA, this provides guidance for LLPs, including clauses to prevent the partnership from folding if a single member leaves

Advantages of Business Partnerships

Let’s look at some of the advantages of business partnerships which can be important if you pick this as the business entity type for your venture:

• Easier to launch a business thanks to all partners bringing equity, experience or time
• Partnerships can combine different skills to create a viable business
• Relatively straightforward business structure with low costs to set up
• Simple structure when it comes to taxation and reporting
• Option to limit the liability of one or more of the partners which can encourage investors
• Variety of different partnership models can cater for a range of scenarios

Disadvantages of Business Partnerships

Of course, it’s not all good news. Business partnerships are not’ the right choice for everyone. Here are a few of the disadvantages of business partnerships which are worth thinking about before you get started on your entrepreneurial journey:

• Some partners may have unlimited liabilities for business debts or legal issues
• Rates of tax may be higher compared to other company structure options
• You’ll need to draft a thorough business partnership agreement to set out how you intend to work together
• Partners may disagree on business issues, causing conflict
• If one partner leaves the business may need to dissolve

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How to Form a Business Partnership

Business partnerships are one of the most common entity types in the US, particularly for newer entrepreneurs. The exact process to form a business partnership might vary slightly from state to state - some of the governance of partnership agreements³ can also vary depending on where you’re located. You’ll need to make sure you know the details of partnership arrangements in your specific location, but the process of forming your business partnership and getting registered is not usually all that complex. Let’s walk through the basic steps you’ll need to take.

1. Choose a Partnership Type

Different partnership types suit different scenarios. Options you’ll want to consider include General Partnerships, Limited Partnerships and Limited Liability Partnerships.

Any of these three might suit your needs - but some are more common in certain scenarios. A Limited Partnership might appeal if you’re creating a business with one or more investors who don’t intend to be involved in the day to day operation of the company. Or a Limited Liability Partnership might be a fit if you’re in an industry where one partner could be individually sued or accrue individual debts, for example.

Picking the right partnership type for your needs is an essential step - so if you’re not sure which might work best for you, it’s time to get some advice from a lawyer.

2. Draft a Partnership Agreement

Partnership agreements can legally be either oral or written but it is best practice to have a written agreement. This also limits the likelihood of misunderstandings or disagreements down the road.

You’ll need to create a partnership agreement when you first enter into a partnership, and can then amend or adjust it as you need to. Some rules apply about when adjustments can be made, including that changes made after the end of a given tax year must be agreed prior to your tax filing date.

There may be different information which needs to appear in your partnership agreement, depending on the type of business you’re creating. However, you’ll always need to detail business information such as your registered trading name and the amount of capital or other assets being contributed by each partner. Your partnership agreement must also capture profit sharing information. To avoid issues down the line, it’s sensible to cover dispute resolution, and what will happen if one partner decides to end involvement with the company.

If your partnership doesn’t cover a specific topic, local law in the state you’re registered in will be taken to be the agreement made.

3. Register the Partnership

You’ll need to register the partnership in the state - or states - you intend to trade in, which is usually done online with the Secretary of State.

Prior to registering you’ll need to make sure your preferred partnership name is available and complies with any local rules about company names. Resources to check name availability, and to then register your partnership, are available online, with detailed explainers and resources to guide you through the process. This means you can register your partnership yourself without needing to turn to an agent if you’d like to, although business formation experts are also available to support if you need help.

Once you’ve registered your partnership, you’ll also need to finish up other legal and tax-related requirements, such as getting a tax ID number, any permits needed based on your specific line of work, and opening a business account with a bank or other non-bank service provider.

Business Partnership Agreement

While business partnerships do not legally need to create a written partnership agreement, this is definitely advisable. Your agreement can technically be verbal, but this is much more likely to give rise to misunderstandings or disagreements. If there’s no agreement in place, or if your agreement is incomplete, local law will be the final decider on any dispute.

Business partnership agreements can include many different clauses, depending on the business type and your requirements. You’ll pretty much always need to include information such as:

• Details of the partnership - which type of business partnership model have you entered into, and in which state are you registering
• Details of the business - your partnership name, purpose and duration if agreed in advance
• Details of the partners - partner personal information, the role of each partner and the contributions made by each
• Information about revenue and any losses - profit sharing agreements and what will be done in the case of losses
• Dispute resolution - steps to be taken in the event of disagreements between partners
• Dissolution - what will happen if one partner leaves, or if all partners agree to sell or close the partnership

Having a thorough and clearly set out partnership agreement is the foundation of a successful business partnership, so it’s worth investing time in drafting an agreement all partners are comfortable with.

Conclusion

A partnership is a business owned by two or more people. The most common business partnership models are General Partnerships, Limited Partnerships and Limited Liability Partnerships. Partnerships are attractive as they give the opportunity to pool resources, skills, capital and expertise to create a business - this can make it far easier to get a viable idea off the ground, compared to going it alone. However, there are also some downsides - including the risk of disagreements or dispute.

One important factor of partnerships is that while businesses that are partnerships must file income reports to the IRS, they do not pay income tax as a business. Instead, partners benefit from pass-through taxation in which they detail business profit or loss in their own personal tax return.

Registering a partnership can look a little different from one state to the next, but it is generally one of the more straightforward ways to get your business up and running. Use this guide to start your research and decide how to proceed with your new business partnership.

What is a business partnership: FAQ

What is the difference between a US LLC and a partnership?

A Limited Liability Company (LLC) is a different business entity type to a partnership. LLCs are considered to be separate entities to their owners, which creates a clear distinction between the legal and financial dealings of the business and the individuals involved. In a partnership, partners and their businesses are treated as one and the same, although there are partnership models which can offer some limitation of liabilities.

What are the four types of business partnerships?

Four possible partnership models are available - although not all are offered in all states:

• General Partnership (GP)
• Limited Partnership (LP)
• Limited Liability Partnership (LLP)
• Limited Liability Limited Partnership (LLLP)

What is the difference between a limited company and a partnership?

The key difference between a company and a partnership is that in a company the owner and the business are considered to be separate entities legally and financially. In a partnership this distinction is less clear, as partners usually take on some or all of the financial and legal risk of their business, and may get pass-through taxation on profits.

What is the difference between LLP and partnership?

A Limited Liability Partnership (LLP) is different to a General Partnership (GP) in that the partners in an LLP are not usually accountable for errors or issues created by another partner. If you’re in an LLP and one partner is sued for malpractice, for example, other partners would not bear responsibility for this. This model is common in professional firms such as doctors, accountants, lawyers and architects.

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Sources:

1. IRS - business structures
2. IRS - partnerships
3. IRS - partnership formation