Setting up a Partnership

Under certain narrow circumstances, you and your co-founder should establish a common partnership. But here

Seems simple, right? You and a buddy, or you and your spouse, want
to set up a business. So you form a partnership and – voila! – you open
shop.

Actually, things are more complicated than that
when it comes to establishing what’s known as a regular or “general”
partnership. It turns out, for nearly all startups, that it’s not a
good idea to settle for that structure.

Here’s how to tell whether the cautions about partnerships apply to you:

  • Realize you’re legally vulnerable
  • Understand the default rules
  • Draw up your own partnership agreement

Realize you’re legally vulnerable

Just as with sole proprietorships
operated by individuals, general partnerships don’t protect you and
your partner, or partners, against legal claims that might be brought
against your business. You and your partner’s individual assets are
just as vulnerable, legally, as your business assets are.

“If you form a limited liability corporation [LLC] or some other legal entity
for your partnership, on the other hand, you’re going to be protected
from the start against liability problems,” says Jeffrey Ferrara,
partner with Boyer & Miller, a business-law firm in Houston.

Understand the default rules

Partnerships
can get sticky, of course, if you and your partner decide to split up,
or get into a dispute about how to divide profits, or responsibility
for losses.

By default, in all such cases, the rewards
and responsibilities of general partnerships are divided exactly in
half between the two partners, in thirds among three partners, and so
on. Most states embody this equal-share principle in laws governing
general partnerships, usually in something called the Uniform
Partnership Act.

And even if you’re down with the
equal-share aspect, it’s not wise to leave the terms of your
partnership up to these default laws. They may not be helpful in your
particular situation. It’s much better to put your agreement into a
document that specifically sets out what you and your partner have
agreed on.

“One of the other default provisions – which
catches many partnerships by surprise – is that all the partners are
equally authorized to bind the partnership,” says Rob Markworth,
partner in Shanahan Law Group, a Raleigh, N.C. “That means anyone who
can sign off as a partner can sign any contract, obtain financing,
or anything else. That means you run the risk of one of the partners
going off and doing something that would jeopardize the whole
partnership.”

Draw up your own partnership agreement

There is a narrow range of circumstances in which a general partnership might make sense as your business structure, including certain professional-service industries
and real-estate companies. But whatever reasoning compels you to stick
with a general-partnership structure, make sure that you and your
partner specify, in a written agreement, exactly how the rewards and
responsibilities of running your company will be divided – even if
everything is 50/50.

Our Bottom Line

General
partnerships don’t come highly recommended as a legal structure for
your company. If you form one, make sure you’ve protected yourself and
your partners with a very specific partnership agreement.

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