Partnership Basics

In California, partnerships come in three varieties, general partnerships, limited partnerships and a species of Limited Liability Company (L.L.C.) that looks and is structured like a partnership. It is also possible that, for tax purposes, that a corporation (especially "S" corporations) may have A general partnership is defined as, "an association of two or more persons to carry on as co-owners a business for profit." Unlike a sole proprietorship, a partner has two or more persons and therefore it is necessary that they reach a rather detailed legal agreement.

Generally the law does not require that a partnership agreement be in writing, however, a partnership agreement in writing is recommended because as time goes on memories fade and individual desires change, but the partnership needs to keep going in business. It is generally, therefore, recommended that a properly drafted (using an attorney) partnership agreement be reached prior to investment of large sums of money. As in many cases, should any litigation be instituted by third parties against any member of the partnership or between the members themselves, the partnership agreement will help to resolve many situations that otherwise might cost tens of thousands of dollars to go through court. It is much better to pay for a competent attorney to prepare proper agreements up front and try to prevent such issues.

GENERAL PARTNERSHIP: As with a sole proprietorship, a fictitious business name statement must be filed and published if necessary. You must apply for business licenses and obtain premises or space to do the business. Raising capital is generally done through the partners' initial capital contributions and loans to the partnership from the partners themselves and others. Partnership interests can generally be deemed "securities", so do not sell such interests to anyone outside the partnership without seeking legal help first.

INTELLECTUAL PROPERTY may be owned by the partnership but only if there is a fictitious business name statement on file. Generally when securing (registering) copyrights and trademarks, and when applying for patents, since the partnership is not a "legal entity" it cannot own property, except as a "d.b.a.". Thus when these applications are made, they recite that the persons who form the partnership own the copyright or other IP "doing business as" the name of the partnership. This is also true if the partnership consists of two or more corporations that formed it. Naturally, one of the partners can own the IP but from many years of partnership litigation in these matters, it is generally best for all to own them collectively so that the IP cannot be held as collateral by one of the partners against the others. If one partner is to own the IP or any of it, there needs to be a written agreement between that partners that allows for it to be used only by the partnership, to preserve goodwill and the like.

Management and control, as well as many other aspects of the partnership, can be shared among the partners. A managing partner can be appointed or a majority or other vote be required.

Generally, partnerships are not perpetual and can be automatically dissolved by certain events unless otherwise agreed to in the partnership agreement. For example, California law provides for the automatic termination of a partnership if one partner dies or withdraws. This is called "inadvertent dissolution" and can be avoided through a proper partnership agreement in writing. Partner's interests are not generally, but can be transferred.

Liability Aspects: All partners jointly and severally (each partner and all the partners) share the risks according to partnership law or otherwise as agreed to in a written partnership agreement. As in sole proprietorships, there should be a partnership business insurance policy that covers each and every partner, as well as the partnership "entity" as a business for fire, theft, injury and other liability.

If, for example, one of several partners should go bankrupt, and there is no partnership agreement to the contrary, the partnership could automatically dissolve. Any creditors who sue the partnership would not be able to sue the partner in bankruptcy, leaving the other partners to carry the burden of debts.

Tax Aspects: Since partnerships are not a "legal entity," so the tax burdens and benefits are shared by the partners themselves. Partners are taxed on their share of profits and may take advantage of their share of losses. The partnership is basically a "pass through" business where the income and losses flow through to the partners who are responsible for payments of their share of tax. See the article on "S" corporations to find out how to structure a Corporation to be taxed like a partnership.

LIMITED PARTNERSHIP: A California limited partnership is "a partnership formed by two or more persons under the laws of this state and having one or more general partners and one or more limited partners." A limited partnership is not as easy to form as is a general partnership, because California law requires filing a Certificate of Limited Partnership, signed by all general partners, filed with the Secretary of State. In this instance, partners need a limited partnership agreement in writing. Preparing a limited partnership agreement can cost more than articles of incorporation, however those who use this form of business usually enjoy the limited liability and tax aspects of limited partnerships. Limited partnerships raise capital the same way general partnerships do except that a limited partner's interest can be deemed "securities." Management and control of a limited partnership is performed by the general partners. Limited partners must not participate in management generally. Though the partners must file a Certificate of Limited Partnership, this may be done before or after entering into a written or oral partnership agreement.

Liability Aspects: General partners (those who manage and control the business) have an unlimited liability, similar to a general partnership. Limited partners, since they take on no responsibility for the management, control and daily operations of the partnership, have the risk of loss limited to their capital contribution. There are exceptions to this if a limited partner actually performs some management and/or control. A third party suing a limited partnership can sue both the general and limited partners, but the limited partner is only liable up to the amount of their capital contribution.