A sole proprietorship is a business in which one individual owns and operates all functions of the business. This same individual has total control over the business, receives all profits, and is responsible for all taxes and liabilities. The greatest disadvantage to a sole proprietorship is that the sole owner is personally liable for the debts of the business. For example, if your business owes $10,000 on a contract, and it cannot pay, then you likely will have to pay the $10,000 out of your own checking account. Because sole proprietors are personally liable for all business debt, it is very important that one carefully consider the nature of their business and whether establishing a sole proprietorship is right for them.
Partnerships occur when two or more individuals own and operate a business together. There are three types of partnerships: a General Partnership, a Limited Partnership, and a Limited Liability Partnership. Each kind of partnership has its own unique advantages and disadvantages and requires careful consideration.
1) General Partnership:
A general partnership occurs when a business has more than one owner or operator and the business does not create a business entity. The good news is that under a general partnership there is “pass through taxation” - that is, the business entity does not get taxed as though it were a separate entity. The bad news is that under this default business structure each partner is liable for the debts of business just as under a sole proprietorship. This means that, like a sole proprietorship, if the business cannot pay a debt it owes, then the owners will have to do so out of pocket. Further, if a general partnership is formed then each partner will owe certain duties to one another delineated by law. Because these are fairly serious responsibilities, it is important to become as informed as possible about a general partnership if you are considering forming a business entity.
2) Limited Partnership:
Limited partnerships, like general partnerships, enjoy pass through taxation but also enjoy some liability protection. Specifically, partners are divided into two classes: general partners and limited partners. General partners are responsible for the running of the business but remain personally liable for its debts. Limited partners, on the other hand, enjoy protection of their personal assets but may not act over the management and control of the business. It is for this reason that choosing a limited partnership structure requires careful legal drafting so that limited partners are not found by a judge to be general partners at a later date and general partners do not run rampant with control.
3) Limited Liability Partnership:
Limited Liability Partnerships are the best of General Partnerships and Limited Partnerships. All of the partners enjoy pass through taxation and will usually not be personally liable for the debts of the business. Moreover, unlike a limited partnership, each partner may partake in the management and control of the business without being personally liable. The main drawback of this business structure is that it requires proper filing with the state of California and the state of California only makes this structure available to certain kinds of businesses.
Creating a Partnership in California
There are three basic steps that must be taken to form a limited or limited liabilty partnership partnership:
- Chose a name;
- Registration with local, state, and federal offices;
- Create of a Partnership Agreement.
While a Partnership Agreement is not required, it is highly recommended to create one. This document will spell out the duties and responsibilities of each partner, and in effect acts as a contract between the partners.
The San Francisco Business Law Attorneysof Jones & Devoy can create this document for you, and help you and your partner(s) avoid any future problems.