Eliminate this P-word from Your Business Vocabulary (or Use Protection)
Given our current political climate, there are probably a few P-words, we should all avoid using in business, however, today, I want us to discuss one that is G-rated. Partnership.
A partnership is a business organization where two (2) or more people own and operate a business together. Texas law states that "an association of two or more persons to carry on a business for profit as owners creates a partnership." (Tex. Bus. Org. § 152.051). That's all it takes and that's part of the danger of a partnership.
Now mind you, there are different types of partnerships that exist--limited partnerships, general partnerships, and limited limited liability partnerships--and they have different levels of risks associated with them. Nevertheless, when compared with other business entities available, there's rarely any need to really employ any of these business forms. This article will use the general partnership to highlight the key issues with this particular business form. General Partnerships:
- Expose owners to unnecessary legal liability,
- Form too easily,
- Change easily making them unstable, and
- Provide little incentive to handle BUSINESS.
1. General partnership expose owners to unnecessary legal liability.
One of the key characteristics of a general partnership is that all the owners are personal liable for the actions of all the other owners. What this means is that you and your personal property could be at risk because of the decisions someone else makes for the business. This could include decisions that you did not even know about because the general partnership structure gives owners that ability to make decisions without consulting other owners.
Here's an example to drive it home: Susie and Bob enter into business together as partners. Three days after they start, Bob decides that business needs a new car to attract clients so he goes to the TESLA store and purchases the car under the business name. Susie has no idea that this purchase has been made. The business goes through the usual first year struggle and is not profitable the first year and Bob can't pay. Guess who's partially responsible for the payments? Susie! Guess who can be held responsible if that bill doesn't get paid? Susie again.
This is the number one reason to avoid partnerships. There are other entities like the LLC and Corporation that don't have this risks--especially if you run them well.
2. General Partnerships are TOO easy to form.
As the definition posted above stated, all that is required to form a partnership is two people conducting business together for profits. Texas law further explains this by saying a partnership can be created even if the people involved (1) did not intend to create a partnership, and (2) don't call it a partnership.
Listen, if you do business with someone for profit, you could be a partnership right now and not even know it. So the liability that Susie from earlier faced, is the same liability that you face--AND you didn't even know it. I know it's crazy, but this is well established law.
Additionally, because intent is not required to form a partnership, using the P-word could be used in litigation to support a finding that a partnership exists where a partner is trying to fight the finding.
3. General partnerships change easily making them unstable.
Another characteristic of a partnership is end when the owners change. The partnership that signed the contract today could be different from that will sign one tomorrow if the owners change. What that means legally is that the contract that you formed as partnership A might not be enforceable against anyone because the parties to contract are different.
That essentially means that some of the protection a contract provides is eroded because of the partnership's instability.
4. General partnerships provide little incentive to handle business.
So unlike some of the other forms of business, it takes no registration, no filings, and no money to create a partnership...which can be good, however, embedded in the structures of some of the other limited liability business entities, there are record filing and record keeping requirements that help people take their business seriously.
Additional Protection for Partners
If after reading the above explanations you still want to go ahead with a partnership, my number one caution to use is to protection--the Partnership agreement. You might think there are no risks involved, but that's rarely the truth. You should use your partnership agreement to:
- identify the parties in the partnership,
- document the contributions of the partners with regards to finances and services,
- explain how profits, losses, and salaries will be handled, and
- add some stability and continuation within the partnership.
Regardless of what entity you form, great care and consideration should be employed to protect you and your business. For more information about the different types of business entities, read my article here about the different types of business entities.
Are you or someone you know in partnership? What are some of the unique challenges you've faced knowingly or unknowingly? Post your comments and stories below.