A partnership is a business agreement between two or more people who are called "partners." Each partner owns a share of the business personally. This is a less expensive business structure and is more customizable than a corporation. The attractive attribute of a partnership is that profits and losses are passed on directly to the partners, thereby avoiding double-taxation incurred through a corporation. There are three types of partnership structures: general partnerships, limited liability partnerships and limited partnerships. Each has unique characteristics, benefits and risks. A fourth category—joint venture partnership—is a separate type of business structure.
A general partnership is an agreement between two or more people who share equally in the profits and liabilities of a company. This can be as informal as a verbal agreement made over coffee or a formalized contractual agreement between partners. There are no requirements for business structure or governance; it is entirely up to the partners to define how the company is to be run and who runs it.
Profits or losses for each general partner are reported as personal income on a Schedule K-1 and the company itself is not taxed on earnings. Corporations are subject to tax on earnings passed on to the owners, who pay tax on the same earnings on their personal income tax returns. Avoiding this double-taxation is a key advantage to owning a partnership.
General partners are also responsible for the company's solvency and liabilities, making this arrangement very risky. Unlimited liability rests on each partner, even if one partner is solely responsible for any illegal activities or financial problems. Further increasing the risk for general partners is the fact that each can act independently on behalf of the company without consent from the other partners.
Limited Liability Partnership
Limited liability partnerships offer the same tax advantages as a general partnership but include some protection for partners' personal assets by limiting their liability to their interest in the company. All partners are allowed to manage the business, similar to the general partnership; however, a formal agreement is required for this business type. This structure keeps all partners from subjecting their personal assets to business liabilities. For example, Jim and Bob are attorneys and set up a limited liability partnership to share in each others' success. Their firm is sued by a former client, but neither Jim nor Bob have personal assets at risk.
Though they share similar names, a limited liability partnership and a limited partnership are quite different. A limited partnership requires at least one partner to manage and take on all risk, while passive limited partners enjoy no liability. The specific rights and responsibilities of limited partners must be laid out in the partnership agreement. For investment purposes, a limited partner is a prudent position in a partnership because only the partnership interest is subject to liability; however, legal limits on the actions of limited partners can be too restrictive for some.
Joint ventures exist in between contractual arrangements and limited liability partnerships. As with contracts, joint ventures are generally short-lived, however, they are legal entities that need to be set up and registered like a corporation or partnership. Why would business associates want to form a joint venture rather than just sign a contract? Ventures are necessary when the project is complex enough to require a specific management team or its own operating infrastructure. A contract can't raise capital, but a joint venture can.
(For related reading, see: How are business decisions made in a partnership?)