Managing Attorney
When two or more individuals decide to go into business together, one of the simplest ways to structure their enterprise is as a general partnership. This traditional model of co-ownership is appealing for its ease of formation and shared control, but it also comes with significant legal and financial risks.
At Capstone Legal Strategies, we help entrepreneurs assess which business structure best supports their goals. If you’re considering a general partnership in Houston, here’s what you need to know about the benefits, the drawbacks, and how it compares to other options like LLCs or corporations.
What Is a General Partnership?
A general partnership is a business arrangement in which two or more individuals agree to operate a business together and share profits, losses, and responsibilities. Unlike corporations, limited partnerships, or limited liability companies (LLCs), general partnerships typically:
- Do not require formal registration with the state (though local business licenses may still be required)
- Are governed by a partnership agreement, which can be oral or written
- Provide no liability protection for the partners
Advantages of General Partnerships
1. Simplicity of Formation
General partnerships can be created with minimal effort. In many cases, a partnership is formed simply by two people conducting business together and sharing profits.
Scenario:
Ethan and Raj start a landscaping business. They split the earnings evenly and share tools and clients. Without filing any paperwork, they’ve likely created a general partnership under Texas law.
2. Cost-Effective Startup
There are usually no formation fees or state filings required. Legal and administrative costs are low, especially compared to forming an LLC or corporation.
3. Pass-Through Taxation
The partnership itself is not taxed. Instead, profits and losses pass through to each partner’s individual tax return, avoiding the double taxation that corporations may face.
4. Shared Decision-Making and Resources
Each partner brings their own skills, network, and capital, and responsibilities are divided according to the agreement.
Scenario:
Maria handles marketing, while James oversees product development. Their complementary strengths allow them to grow their online business efficiently.
Disadvantages of General Partnerships
1. Unlimited Personal Liability
This is the most significant risk. Each partner is personally liable for business debts and legal obligations, even if the other partner incurred the debt.
Scenario:
If Raj takes out a business loan without Ethan’s knowledge and defaults, Ethan could still be held personally responsible for repayment.
2. Lack of Legal Separation
There’s no distinction between personal and business assets, which can jeopardize your personal finances if the business is sued or falls into debt.
3. Potential for Conflict
Without clear roles and responsibilities, disagreements over business decisions, finances, or exit strategies can derail operations.
4. Difficulty Raising Capital
Investors may be reluctant to fund general partnerships because of the lack of structure, limited liability protection, and continuity concerns.
General Partnerships vs. Other Business Structures
When choosing a business structure, it’s important to understand how general partnerships compare to other popular options like limited liability companies (LLCs), limited partnerships (LPs) and corporations. Each offers different benefits and protections depending on your goals and risk tolerance.
General Partnerships:
- Formation: Easiest to set up—often created automatically when two or more people begin doing business together.
- Liability: Each partner has unlimited personal liability for business debts and legal actions.
- Taxation: Offers pass-through taxation, meaning profits and losses are reported on each partner’s personal tax return.
- Management: Partners typically share control and decision-making equally or according to a partnership agreement.
- Best for: Small businesses and professional partnerships where partners trust each other and want a low-cost, flexible structure.
Limited Liability Companies (LLCs):
- Formation: Requires formal registration with the state and filing of articles of organization.
- Liability: Provides limited liability protection, shielding personal assets from most business liabilities.
- Taxation: Pass-through taxation by default, but can elect to be taxed as a corporation.
- Management: Flexible—can be member-managed or manager-managed, depending on the operating agreement.
- Best for: Small to midsize businesses seeking legal protection with operational flexibility.
Limited Partnerships (LPs):
- Formation: Requires formal registration with the state and filing of a Certificate of Incorporation/Certificate of Formation for the General Partner and a Certificate of Formation for the Limited Partnership.
- Liability: General Partners have unlimited liability for debts and obligations. Limited Partners only have liability up to their investment, provided they do not participate in the management.
- Taxation: Pass through taxation. Self-employment tax generally does not apply to limited partners. Able to allocate profit and loss not strictly on a pro-rata basis (as permitted in the limited partnership agreement).
- Management: Managed by the General Partner.
- Best for: Any sized business looking for tax efficiency and flexibility with regards to allocation of profits and losses.
Corporations:
- Formation: Requires filing of articles of incorporation and adherence to more rigid governance structures.
- Liability: Shareholders enjoy limited liability, protecting personal assets from corporate debts.
- Taxation: Subject to double taxation (on profits and shareholder dividends), unless filing as an S corporation.
- Management: Managed by a board of directors and officers, with more formal record-keeping and compliance obligations.
- Best for: Larger businesses, startups seeking investors, or companies planning to scale significantly.
Each structure carries trade-offs in terms of legal protection, tax treatment, complexity, and operational control. At Capstone Legal Strategies, we help you evaluate these differences in the context of your business’s size, industry, and long-term plans.
Tax Considerations
- IRS Form 1065: General partnerships file an informational return but pay no entity-level taxes.
- Schedule K-1: Each partner receives a K-1 showing their share of profits or losses.
- Self-Employment Tax: Partners in a general partnership are considered self-employed and must pay SE tax on their earnings.
- Deductible Business Expenses: Ordinary and necessary business expenses may be deductible on the partners’ personal tax returns.
Is a General Partnership Right for You?
While general partnerships are easy to form and operate, they are best suited for low-risk businesses with a high degree of trust between partners. If you are concerned about personal liability, long-term growth, tax efficiency, or investor needs, you may be better served by a different entity type.
At Capstone Legal Strategies, we help business owners evaluate their options and draft partnership agreements that address key issues like ownership percentages, decision-making authority, dispute resolution, and exit plans.
Your Trusted Business Formation Lawyers
General partnerships offer flexibility and ease, but that simplicity comes with trade-offs in liability and control. Whether you’re forming a new business or reassessing your existing structure, it’s important to weigh the risks and rewards with sound legal guidance.
Looking to start a business with a partner? Contact Capstone Legal Strategies to explore whether a general partnership is right for you and how to protect your interests from day one.