Defaulting Into A Business General Partnership

When it comes time to start a business, many people just get on with the process without really thinking about issues like taxes, liability and business entities. This can lead to unintended consequences.

If you start a business and are the sole owner, you are automatically considered a sole proprietor. You have no protection from liability for the debts of the business and you file your taxes on Schedule C of your 1040. Most people understand this, but what happens if there are two owners and no business entity is selected?

To the surprise of many, a business with two or more owners that does not actively form a business entity is considered a general partnership. A general partnership is generally not an entity that should be used unless you absolutely must. Why? Well, the entity provides no liability protection to the owners. If you partner takes a client to lunch, has a few drinks and then crashes into another car on the way back to the office, he, you and the business are all liable for any lawsuit judgment.

Another area where a general partnership can be problematic is the administration. Since most businesses default into a general partnership, the owners have nothing in writing regarding their wishes. What happens, for instance, if one is disabled or dies? Unless something is in writing, the issue will default to the courts where a judge will make a determination. Obviously, such a process is both expensive and time intensive.

All and all, general partnerships should be avoided wherever possible when running a business. Alternatives that provide superior liability protection include LLCs, corporations, limited partnerships as well as other entities. The "best" choice for your business depends on the specifics of your situation.

If you find that the general partnership is really the only way for you to go, then it is vital you enter into a written partnership agreement with your partners. Don't leave it to a court to interpret! Trust me. You will regret it!

Richard A. Chapo is an attorney who helps businesses incorporate in California and can be found at SanDiegoBusinessLawFirm.com.