The dynamic between risk and return is a fundamental part of how you invest. Whenever you make any financial decision, you should have the wherewithal to ask discerning questions, like if a general partnership fails, who is responsible for real estate debt?
Explore the ramifications of entering into a general partnership so you can make the right financial decisions that protect your finances.
What Is a General Partnership?
A general partnership is a financial and business arrangement between at least two parties. In a general partnership, the participating parties agree to share in every financial and legal aspect of the agreement: assets, profits, debts, and liabilities.
Essentially, general partnerships stand apart from other financial and business arrangements because they operate with unlimited liability—liabilities are not capped in a general partnership. Unlimited liability means that parties involved in a general partnership may seize their assets if the GP goes belly up.
Investors turn to general partnerships despite their potential risk because they have more flexibility than other business arrangements. Incorporated business arrangements and even LLCs do not have the financial agility of general partnerships. General partnerships can move fast, which means investors can operate with the quickness that keeps them ahead of the curb.
How Do General Partnerships Work?
General partnerships are the loosest possible business arrangements investors can make. They are legally considered unincorporated businesses; therefore, general partnerships are not required to register with the state.
Many investors consider their unregistered status a strength; this is the critical factor contributing to a general partnership’s swiftness. The only necessary conditions that a general partnership must meet are:
- The partnership must consist of at least two or more parties.
- All participating parties assent to unlimited liability for the general partnership individually.
The guiding structure of the partnership is agreed upon by general contracts between the parties, like a founders’ or partner’s agreement.
General partnerships are so flexible that these foundational agreements do not need to be formally written—they can be agreed upon orally. Incorporated entities can take many forms in financial arrangements; general partnerships are the loosest of all financial or business arrangements.
Who Participates in General Partnership?
In a general partnership, all parties will likely have some role in the arrangement. For comparison, in a limited partnership, there are usually one or two general partners who utilize capital funded by investors—limited partners.
Limited partners do not take the active role in a fund or business’ management that general partners do. Limited partners put up the money to gain access to the fund. Their limited part in the arrangement comes with lower return rates than general partners. However, limited partners are better protected from liability than general partners.
General partnerships, as their name suggests, consist solely of general partners. Partners’ roles in the fund can vary; again, the defining feature of general partnerships is their relative ambiguity when compared to more explicit financial arrangements; these particulars are outlined in the founders’ agreement established in the firm.
All general partners participate in their arrangement. General partners may take varying management roles and act with high degrees of independence from one another. What unites them is a shared distribution of funding, capital gains, and liability.
General Partnerships & Real Estate
General partnerships are a typical financial arrangement for real estate investors. Real estate is a substantial investment but often has high economic thresholds. For instance, residential properties are high-value assets that prospective homeowners usually take out mortgages to acquire. However, other property types can be considerably higher: commercial real estate and industrial real estate, for instance.
For many investors, general partnerships create a financial arrangement that allows them the opportunity to invest in remarkably high-value assets they would otherwise be unable to access. As unincorporated financial arrangements, general partnerships don’t take much paperwork to form. That means high net-worth individuals who would otherwise be unable to access high-value real estate assets on their own can pool funds together with like-minded investors.
Everything is shared in a general partnership: the funds used to acquire new properties, the profits generated by assets that perform, and the debt incurred on properties held by the partnership.
Who Takes on Debt in a General Partnership?
Partners bind their fate together when they enter into a general partnership; any partner’s decisions affect the rest of the general partnership. If an asset fails, all parties involved in the general partnership may be on the hook for debt incurred in the arrangement.
Even if one partner incurs debt independent of the other partners, that debt is the other partners’ responsibility. The necessary conditions required to form a general partnership mean that all partners agree to unlimited liability between them; all parties are subject to the risks brought by even one participant in the general partnership.
By their founding agreement, general partnerships can put any of the partners involved at risk through the actions of another. When forming a general partnership, you must completely trust your partners. The actions of any involved participant can have severe consequences for the rest of the partnership. For that reason, you should be completely confident in the capability of your partners; their actions could saddle you with serious amounts of debt.
What Are the Benefits of a General Partnership?
General partnerships are a compelling financial arrangement for investors because, despite their risks, they host several benefits for the parties involved. Here are the most substantial advantages of participating in a general partnership:
- Easy to start
- Favorable tax rates
- Easy to dissolve
Easy To Start
The unincorporated status of general partnerships means that they are easy to form. Investors with the connections and means to start a general partnership easily; by creating a general partnership, investors can gain access to assets they would otherwise be unable to access. The ease of forming general partnerships means that investors can dramatically increase their financial capability with few obstacles.
Favorable Tax Rates
The most compelling advantage of forming a general partnership is its favorable tax rates. General partnerships are unlike other financial arrangements in that they are pass-through entities, meaning they do not have to pay income taxes as a business.
Because a general partnership is technically a loose confederation of individual investors, their earnings more accurately qualify as individual income, not income earned through an incorporated entity. Therefore, partners only need to pay taxes on income earned as individuals, not as a business.
Easy To Dissolve
Swiftness in finance can make all the difference between success and failure. General partnerships are easy to dissolve, meaning investors have relatively high free reign compared to other, more encumbering financial arrangements.
The ease with which general partnerships are formed translates into a relatively seamless means to dissolve them. Partners ready to move on from their arrangement can do so quickly. If a general partnership looks to be taking a turn for the worse, a partner can remove themselves and protect their finances.
The Bottom Line: Know the Benefits & Drawbacks of a General Partnership
There are countless ways to maximize your financial potential. But for every decision you make, there are drawbacks you should be keenly aware of before getting involved. General partnerships present many advantages for savvy inventors; they have just as many weaknesses that could disrupt an investor’s financial strategy.
A general partnership based on real estate assets requires a reliable capital pool. Finding the most favorable financing options can ensure that your general partnership has the capital to access the best real estate assets.