What is a Partnership?

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When two or more people go into business for themselves to make money a partnership is formed. A partnership generally involves the partners investing in the business and sharing profits and losses with each other. In Tennessee, there are several different types of partnerships and not all of them are the same. Here are the type of partnerships in Tennessee:

  • General Partnerships
  • Limited Partnerships
  • Limited Liability Partnerships
  • Family Limited Partnerships

Each partnership has different formation requirements under the law and each have attributes which make the partnerships distinct. The primary differences between the several types of partnerships is how liability is assessed among the partners and who operates the partnership.

How Does a Partnership Work?

A general partnership can be formed two ways: formally or informally. A general partnership can be formally created by the preparation of a partnership agreement and mutual understanding of the responsibilities of each partner.

Example of Formally Starting a Partnership

For example, George and Ronald want to start a plumbing business in Clarksville. They talk everything over and agree that George will stay in the office and be responsible for all the paperwork, marketing, and day to day business affairs.  Ronald will be the one actually working on plumbing jobs and meeting customers. They hire a lawyer, the lawyer prepares a partnership agreement based upon the terms they agree upon, and boom, a general partnership is formed.

Example of Informally Creating a Partnership

A general partnership could also be created based upon a handshake deal without the formalities of creating any type of written agreement. So, for instance, Wanda and Mary want to create their own stationary store. They agree that Wanda will keep the books, handle online orders, and order supplies. Mary agrees to work the front counter, help customers with questions, and keep the store straight and tidy. They find a cute building in downtown Clarksville and enter into a lease with the owner. They have no formal written agreement but agree verbally how all assets and debts will be split, and how rent is to be paid. Wanda and Mary have formed a general partnership even though there may not be any agreement in writing between them.

Pros and Cons of General Partnerships

If you are considering starting a business, a partnership is certainly a viable option depending on your circumstances. Here are some advantages and disadvantages of partnerships to consider when thinking about starting a business.

Advantages of General Partnerships

  • Easy to Create. General partnerships are very easy to create. They do not require any formalities to start and do not have to be registered with the Tennessee Secretary of State.
  • Sharing of profits and losses. Unless otherwise agreed upon, each partner shares equally in the profits and losses of the partnership. For example, if you and your partner made $10,000.00 you would split that profit equally between the two of you unless your partnership agreement divided the profits differently.
  • Individual Tax Rate. Much like a sole proprietorship, each partner pays taxes on the partnership profits based upon his own individual tax rate. The partnership itself is not taxed.
  • No Tennessee Franchise and Excise Tax. In Tennessee, partnerships are not subject to the Tennessee Franchise and Excise Tax. The avoidance of these taxes is a major advantage of this type of business entity.
  • Avoid Annual Filing Fees and Reports. Unlike LLCs, corporations, and limited partnerships, general partnerships are not required to pay annual filing fees with the State of Tennessee. They are also not required to file annual reports with the State.

Disadvantages of General Partnerships

  • No liability shield. The biggest disadvantage of a general partnership is that each partner is personally liable for the acts of the other partner. For instance, if your partner has a car accident while working, you can be held personally liable for the accident even though you did not cause it.
  • All Partners Responsible for Debts. Each partner is responsible for the debts of a partnership. So for example, if your partnership had a credit card and your partner ran up a high bill that you did not know about, you will be held liable for that debt.
  • Self-Employment Tax. Much like a sole proprietorship, partners are liable for their own self-employment tax. Self-employment tax is a combination of the Medicare and Social Security Tax and is currently set at a combined rate of 15.3%. Even if you only operate the partnership part time and have another full time job, you may still be liable for the self-employment tax.
  • Obtaining Loans. Much like a sole proprietorship, raising funds for a partnership is limited to the ability of each partner to raise individual funds. Lenders can make loans to partnerships, but the partners will have to personally guarantee the loan.

Make Sure You Have a Partnership Agreement

A written partnership agreement is a critical when you create a general partnership. Disputes inevitably arise among partners as to how to split profits, transfer partnership interest, leaving the partnership, and winding down the business. A formal partnership agreement deals with these issues. If you do not have a partnership agreement, Tennessee laws controlling partnerships will apply by default.

Additionally, as a practical matter, most banks and financial institutions will not allow you to open a business account for your partnership without a partnership agreement. So whether you are creating a partnership or already have one in place, seriously consider creating a partnership agreement. It can save you from many headaches down the road.

How Do You Get Out of a Partnership?

Many times exiting a partnership is a bit more complicated than just walking away from the business. Here are the general steps of how to leave a partnership:

  • First, if you have a partnership agreement it will control how your exit will be handled, so make sure you read it carefully. However, note that if you do not have a partnership agreement, Tennessee state law will control you dissociation from the partnership.
  • Second, announce to the other partners you are leaving the partnership. Pick a date for your dissociation.
  • Third, if there are remaining partners that plan to carry on on the business, they must pay you the greater value of:

    1) The liquidation value of your share of the partnership; or
    2) The market value or sale value of your share if the entire partnership were sold.

  • Fourth, if there are only two partners in the partnership, the partnership will be dissolved if you exit the partnership. For the partnership to be terminated, all the debts owed by the partnership must be paid and the remaining assets will be distributed to the partners based upon their share.
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