What Business Type Has Two or More Owners & Unlimited Liability?
There are two often conflicting issues small-business owners must reckon with when selecting the form of business organization. These are the ability to raise capital and personal protection from claims against the business. When the sources of capital are investors who want to participate in the business as co-owners, the general partnership may be the only practical compromise. The downside is that partners share unlimited liability for claims against the business.
General partnerships are formed when two or more people pool their capital to start a business as co-owners. The partners are "jointly and severally" liable for claims and debts against the partnership. Each partner is personally liable for all claims against the partnership. Moreover, if the partnership is sued and a plaintiff recovers damages from one of the partners, that partner can pursue the other partners for their contribution to the recovered damages. Partners typically share all profits and losses from the partnership according to the distribution of ownership in the business. General partnerships enjoy favorable taxation, which can be a bonus for small businesses, because the partners report their shares of profits and losses on their personal tax returns. Lenders also like making loans to general partnerships because the unlimited liability feature spreads the risk among all the partners.
One partner can have a larger percentage of ownership in the partnership than other partners. Because all partners participate in the management of the partnership, important issues normally are decided by a majority vote of the partners where percentage of ownership determines the weight of each vote. The equivalency between percentage of ownership and percentage of votes could be significant in a general partnership made up of, say, two people, where one partner has only a 30 percent ownership of the business yet still has unlimited liability for claims against the partnership.
Unlike other forms of business organization, partnerships can be formal, with all the mystifying legal paperwork, or informal, based merely on your working with other parties to make a profit. The Uniform Partnership Act of 1997, Section 202 defines a partnership as "the association of two or more persons to carry on as co-owners of a business for profit forms a partnership, whether or not the persons intend to form a partnership." This definition of "partnership" should sound the cautionary note that you might already be in a partnership by default regardless of your intent if you are engaged with others in a profit-making venture.
It is best formalize your partnership agreement to avoid the potential for unwanted surprises. Moreover, a formal partnership agreement is the best way to avoid partner conflicts in the assignment of responsibilities. Partnership authority should be clearly defined, particularly for legally binding contracts and agreements, where there's potential for litigation. Discuss the assignment of management responsibilities and authority with your prospective partners as a first step. Then, contact an attorney to formalize the agreement. Fortunately, the Uniform Partnership Act, which is applied according to the laws of your state, is very flexible regarding how partners choose to organize their business, providing the agreement is formalized.
Unlike democracy, the will of the majority in partnerships cannot override the will of the minority. One intransigent partner can gridlock a partnership. The only meaningful way to resolve some partner differences is to dissolve the partnership. Consequently, it is prudent to exercise caution when selecting co-owners for your partnership.