A lot of today’s most successful businesses started out as general partnerships. After all, starting a business is simultaneously exciting and overwhelming.
Having a partner to share the load makes it that much easier. And partnerships in California are easy to form, so it’s not surprising that many entrepreneurial teams begin with this entity type. But even though partnerships are easy to form, there are plenty of ducks to put in a row.
In this guide, we’ll walk you through all the essentials to forming a partnership, from the liability risks of a general partnership to business licenses, and more. By the end, you’ll have a clear picture of how to start a general partnership in California.
A (Very Important) Note on Personal Liability
If you talk to a lawyer about your intentions to start a partnership, there’s a good chance he or she will tell you to be really careful. That’s because, from a legal standpoint, a partnership is not legally distinct from the individual partners behind the partnership.
Granted, the business can obtain a bank account using the business’s name, enter contracts, and so on. But the responsibility to uphold those contracts and agreements falls to the partners, not the business.
If your partnership defaults on a loan or is sued for malpractice, you’ll (understandably) have to pay up. But if there’s not enough money in your business’s bank account to pay, your creditors can go after your personal assets. For example, they can lay claim to your car, your house, and your personal savings.
Note: Some states allow for partnership types with some liability protection—and California is one of them. The most common types are Limited Partnerships and Limited Liability Partnerships. That said, there are important nuances to these partnership types that make them troublesome for some entrepreneurs.
If you’re not much of a risk-taker (and that’s totally fine; risky endeavors aren’t for everyone), then a general partnership is probably not the best choice for you. You’d be better off forming an LLC or corporation, which offer near-comprehensive liability protection.
For most small businesses, the LLC is ideal because it offers a lot of ownership flexibility, easy operation, and personal asset protection. If you’d like to learn more about forming an LLC in California, start with this guide.
But if a general partnership seems right for your business idea, then let’s dig in. By the time you’ve followed all the steps in this guide, you’ll have a general partnership that’s set for success.
5 Steps to Form Your General Partnership
If you’re sure that a partnership is right for you, then your business starts as soon as you and your partner get to work. That said, there are 5 key steps you should complete to ensure your business gets off to a good start.
1. Do a ‘partner’ gut check
Starting a partnership can be really exciting, especially if you’re entering business with a lifelong friend or a buddy from college.
But don’t rush into things if you can help it. Some people recommend looking at a partnership like a marriage: it’s a committed relationship that requires give and take on both sides. So you should consider your partnership with a long-term mindset.
For example, ask yourself these questions:
- Do you work well together even in stressful situations?
- Do you agree on how to handle finances?
- Do your strengths and weaknesses complement each other?
- Can you envision still working with them 5-10 years from now?
- Does either partner have a history of malpractice, poor business decisions, etc.?
While you don’t have to do a full-scale background check on your potential business partners, careful consideration can save you headaches down the road. Talking through these issues together (before business begins) ensures that everyone is on the same page.
2. Draft a partnership agreement
In every high-functioning business, everyone has clearly defined responsibilities, compensation terms, and rights—all the way from the CEO to the new hire in training. Partnerships may not have as many people involved, but they still require clear-cut roles.
A partnership agreement clearly defines the rights, privileges, and responsibilities of each member.
Each agreement is unique, but every good partnership agreement includes:
- How ownership is split: Does each partner have an even 50/50 share? Or does one partner have a bigger stake, such as a 60/40 split?
- Management rights: Can a partner make decisions autonomously, or do big decisions require mutual agreement? What decisions are “big enough” to require you to consult each other? Simply put, your agreement should detail who calls the shots, and how.
- Duration of the partnership: Not all partnerships last forever; some plan for their business to be temporary. Others plan for a perpetual partnership. Either is okay, but you should detail it in your agreement.
- How a partner can buy in (or out): As time passes, it’s not uncommon for a business to add or subtract a partner. But there needs to be an official procedure for doing so. Your operating agreement can detail that procedure.
3. Choose a DBA Name (Optional)
When you start a partnership, the business doesn’t have a unique name; it’s just the legal surnames of each partner. But “Jones & Jacobs” isn’t a very descriptive name, right?
That’s why a lot of partnerships choose to use a DBA, or “Doing Business As” name. A DBA allows a business like “Jones & Jacobs” to operate as “World’s Best Cupcakes.” Not only is a DBA name more appealing and descriptive, but a DBA also gives you some new options.
You can open a business bank account, and a name makes your business seem more official. A lot of customers are more comfortable writing a check to a business than an individual.
In California, general partnerships are required to register a Fictitious Business Name (California’s title for DBAs) in a few different circumstances. For example, if the business name you want to use includes something like “Co” or it does not contain your surname, you’ll need to register it so there is a record of who the owners of that business are. That said, the California Secretary of State does not handle FBN registrations. Instead, you’ll need to register your FBN at your local county clerk.
However, before you jump into registering your FBN, you need to ensure that it’s not already in use in the state. You can do so by running a search on your county clerk’s website as well as a Name Availability Search. It’s important to note that, in California, your name cannot be the same as or even so similar to another business name that it causes confusion.
Each county sets its own fee for the registration. But once you’ve registered, the name is yours for 5 years. After that, you’ll need to renew your registration. For full details about fictitious business names, you can consult the Franchise Tax Board’s Guide to DBAs.
4. Register for taxes
An advantage to a partnership is the fact that partnerships do not pay taxes as a business; instead, the tax burden “passes through” to the individual members of the partnership. The partners pay the taxes.
That said, your partnership still needs to register with the IRS and file yearly paperwork to report the business’s income. That registration also entails getting an EIN. Obtaining this business tax number is easy and free, and if you do it online, you’ll get your number almost instantly.
Your partnership won’t actually pay taxes to the IRS, but you will need to file a form annually (IRS Form 1065). The actual tax burden will come into play when you fill out Schedule C of your individual income tax reports each year. If you have any employees, you’ll also need to pay employment taxes like Medicare, Unemployment, and more.
For a full description of partnership tax requirements at the federal level, check out the IRS’s Tax Information for Partnerships.
Compared to some states, California has a pretty hefty tax burden, even for partnerships. That’s largely because every business is subject to the state’s franchise tax. Even partnerships need to pay the minimum $800 annual franchise tax (LLCs and corporations often have to pay more than that).
Technically speaking, your partnership won’t pay income taxes as a business, but you will need to file an income report form. Each partner will also report their share of that income on his or her individual tax returns. And then, based on your total personal income, you’ll pay taxes on your share of the partnership’s proceeds. California’s income tax rates can be pretty high; they range between 1% and 13.3% depending on your income levels.
California also expects every partnership involved in retail sales to collect and pay the state sales tax. Currently, the statewide rate is 7.25%, but local districts are allowed to collect an additional fee between 0.1% and 1%. You can read more about California’s sales tax here.
Last but not least, you may need to keep tabs on miscellaneous taxes and fees pertaining to your industry. For example, California has unique taxes for cannabis, diesel fuel, insurance, and more. You can learn all about business tax types at the California Department of Tax and Fee Administration.
5. Obtain business licenses and permits
Even though partnerships are relatively simple to run, they’re not exempt from the state’s business license requirements. In most locations, there are two primary business license categories: the general business license and industry-specific occupational and professional licenses.
California may have a hefty annual tax fee for businesses, but their licensing requirements are a little easier; there is no statewide general business that every business needs to obtain.
Instead, the bulk of California’s licensing requirements come in the form of industry-specific licenses. For one thing, Wyoming upholds all licenses required on the federal level. For example, business owners in industries like alcohol and agriculture need to get licenses from the Alcohol and Tobacco Tax and Trade Bureau and U.S. Department of Agriculture respectively.
There’s also a very good chance that you, your partners, and your employees may need to get one or more licenses specific to your profession within California. For example, the state has license requirements for physicians, chiropractors, landscapers, and more. You’ll need to do some research to learn what your specific requirements are. Thankfully, CalGold makes it easy; it’s your one-stop resource for all things licensing.
General Partnership Pros & Cons
Before you form any business, you’ll want to do some careful soul-searching to ensure that entrepreneurship is right for you. That’s especially true for a general partnership. You’ll need to carefully evaluate the pros and cons before diving in.
General Partnership Pros
- Unlike a lot of business entity types, a general partnership does not require any start-up paperwork or registration fees. You don’t have to submit any paperwork to the state of California. In a sense, your business bursts into existence as soon as you and your business partner(s) say, “Let’s do this!” You can get to work right away.
- Another advantage to a general partnership is the flexibility it provides you. You and your business partners will have a lot more control and leeway when operating your business (especially compared to a corporation). But if you someday decide to convert your partnership into a more official LLC or corporation, it’s easy to do so. The paperwork required is simple.
- Last but not least, you’ll find that your tax burden will be pretty simple as a general partnership. General partnerships file tax paperwork as a business, but they do not actually pay taxes. Instead, the tax burden “passes through” to the partners, who pay taxes at the individual rate for both the federal state levels. In many cases, the individual tax rate is cheaper than the corporate income tax.
(Note: this might not be true if you have extensive income from other sources, pushing you into a high tax bracket). To be fair, California has a pretty heavy tax burden compared to other states, but it’s still usually cheaper to pay as an individual. For more information on general partnership taxes in the state, see Step 4 above.
General Partnership Cons
- The biggest disadvantage to a general partnership is that the partners accept a lot of personal liability. General partnerships do not offer any personal asset protection, unlike corporations or LLCs. We’ll go into more detail about personal liability shortly.
- Let’s face it: sometimes, partnerships just don’t work out. There’s no guarantee that you’ll always see eye to eye with your partners. For example, one partner might lose their passion for the business down the road. Or one partner might sign a contract without consulting you, and you don’t agree to the terms. Members of a general partnership can also be held personally liable for the malpractice of the other partners, which can have potentially disastrous consequences.
Conclusion
There are risks and challenges with a general partnership, but that doesn’t mean that you shouldn’t form one if it actually is the proper route for you. For the right business partners—and with the proper procedures—a general partnership offers exciting, unique opportunities.