Our Pig Farmer Brings in a Partner to Help Run the Show-Pig Operation: Another Reason to Do Business as a Corporation or LLC
In last week’s blog I introduced you to our farmer who raises prize pigs to show at state fairs and livestock shows. Let’s call him Rick, and his operation Prestige Pigs. Rick is running Prestige Pigs as a sole proprietor, a business model that leaves Rick and all of his personal assets—house, truck, as well as the assets of the business, at risk should he be sued. As we discussed, the sole proprietor model provides no limitation of personal liability, which is why Rick should form a corporation or limited liability company (an “LLC”) to hold his business.
Today I want to discuss another business model which will not limit personal liability: a general partnership. A general partnership is defined under most states’ laws as “an association of two or more persons to carry on, as co-owners, a business for profit.” Unlike a corporation or LLC, which requires the filing of certain documents to come into existence, a general partnership is created without any formal action, and the actual intentions of the persons do not matter; if they meet the legal definition, there could very well be a partnership under state law (there are some exceptions) and the business people may not even realize it.
Let’s say that Prestige Pigs is doing very well, and Rick needs some help to run things. Rick asks Selina, a recent graduate of the local agricultural college, to join him in running the business, He promises Selina a share of the profits, rather than wages, because he doesn’t have time to deal with employee paperwork. Selina agrees, and starts working with Rick.
Prestige Pigs is no longer a sole proprietorship, since there are two people in the business. In all likelihood, it is now a general partnership.
Why does that matter? It matters because, like a sole proprietorship, partners in a general partnership have no shield from personal liability. In fact, each partner is liable for the other, so if someone sues Prestige Pigs, both Rick and Selina’s personal assets are at risk. Further, each partner is on the hook for all of the debts of the business, so if Rick doesn’t pay some bills, then Rick and Selina are each personally liable.
Another concern with general partnerships is that, without a written partnership agreement saying otherwise, either partner has full legal authority to obligate the business. So if Selina hears about a new organic, gluten-free hog feed that she wants to try, and signs a contract for a year’s supply without telling Rick, the business is still bound, by that contract.
By bringing in Selina to help with Prestige Pigs, Rick has taken steps to help the business grow, which is what every business owner wants. However, he may have unintentionally created some new risks if Prestige Pigs is now a general partnership. And he has still not solved the problem of unlimited personal liability. To shield his and Selina’s personal assets from liability, Rick should still form a corporation or LLC to hold the assets of Prestige Pigs and be the business model.