Differences between a partnership and corporation

When starting a small business, one of the most important legal and structural decisions owners face is whether to establish a partnership or corporation. The business structure you choose for your small business can impact everything from day-to-day operations, legal protections, taxation, and financing.

Understanding key differences will ensure you choose the best structure to achieve your business goals and set your company up for success.

What is a partnership?

A partnership is a business structure owned by two or more individuals, known as partners. Partners equally share control over business decisions, profits, tax liabilities, and personal legal exposure.

Partnerships are popular among smaller companies as they have low startup costs and require little paperwork. Registering a partnership involves filing a partnership agreement outlining profit/loss distribution and partners’ roles and rights.

Common types of partnerships include:

• General partnership: Partners equally own and operate the business while sharing profits and losses. All partners participate in management decisions and carry unlimited personal liability.
• Limited partnership (LP): Includes at least one general partner who handles management plus limited partners who carry limited liability based on their investment portion. Limited partners typically can’t participate in daily control and operations.
• Limited liability partnership (LLP): Functions like a general partnership but partners have limited personal liability protection against co-partner malpractice or misconduct. Partners still carry unlimited liability for their own actions.
• Joint ventures: A project-based partnership where two or more businesses collaborate temporarily for a specific purpose under shared management and profit goals.

Partnerships are easy to establish requiring little formal paperwork. They allow pass-through taxation with all profits/losses flowing through to partners’ personal returns. However, this unlimited liability can pose a financial risk for partners.

What is a corporation?

A corporation is a legal business entity that is fully separate from the people who own or operate it. Forming a corporation protects owners from personal liability for company debts or legal issues. However, corporations face more regulations and double taxation on profits.

Establishing a corporation requires filing articles of incorporation, usually with the help of a business lawyer. Formal corporate bylaws outline board structures for oversight and officers that handle day-to-day management. Ownership is distributed to shareholders through shares of stock.

Types of corporations include:

• C corporations: Standard corporations with no special tax elections. They face double taxation on corporate profits and shareholder dividends but carry limited liability.
• S corporations: Enable pass-through taxation so earnings pass directly to shareholders, avoiding double taxation. However, these corporations must meet special IRS requirements regarding shareholder numbers and types.
• B corporations (benefit corporations): For-profit companies certified via third parties as meeting higher environmental or social impact standards. They carry limited liability with standard taxation.
• Close corporations: Offer limited shareholder numbers and restricted stock transfers. This smaller structure operates like a hybrid between a partnership and a corporation.

Forming a corporation requires a more complex filing process but carries major advantages like limited liability separation and easier access to financing. Downsides include extensive recordkeeping and double taxation.

What are the differences between partnerships and corporations?

While corporations have more complex requirements, they limit owner liability. Partnerships offer pass-through taxation benefits, but pose financial risks.

Weighing the differences in formation, liability protections, taxation rules, maintenance costs, and raising capital can help small business owners find the best fit for them.

Formation

Partnerships are quick and inexpensive to establish requiring minimal paperwork. Corporations involve a more complex formation process including filing articles of incorporation and creating corporate bylaws.

Ownership and management structure

Partnerships don’t have boards of directors and require unanimous approval among partners for key structural decisions. This gives partners tight control and oversight but can hinder some decision-making. Since partnerships have unlimited personal liability among partners, bringing on additional partners presents a significant financial risk.

With a corporation, founders manage day-to-day operations while shareholders and directors oversee at the ownership level, based on percentage stakes owned. Corporations can leverage more complex ownership structures — with preferred and common shares or equity incentives for employees. Transferring ownership is much simpler with a corporation.

Taxation

From a tax perspective, partnerships are “pass-through” entities — meaning the IRS does not view partnerships as separate taxable entities. Income and losses flow directly to the partners and are reflected on their personal tax returns. Partners pay taxes on their share of partnership income personally.

With corporations, taxes are paid twice — the corporation pays taxes on net income, and then shareholders also pay taxes on dividends or other distributions later on. This double taxation can mean a higher tax burden overall versus a partnership.

In terms of reporting, partnerships must file an annual partnership return, distributing K-1 statements to partners. Partners then report that K-1 activity on their personal returns.

Corporations are more complex — requiring articles of incorporation, bylaws, annual shareholder meetings, stock issuances, and annual returns. Therefore, administrative obligations with corporations are more substantial.

Legal exposure

One of the primary reasons small business owners opt to form a corporation is to protect their personal assets from company debts and legal liabilities.

Partnerships offer very little separation between the company and the owners — partners can be held personally liable for partnership obligations. With a corporation, shareholders are not personally responsible for corporate debts and liabilities beyond the extent of their investment. Personal assets are generally protected from creditors.

If limiting personal liability is a priority, forming a corporation shields owners in a way that a partnership does not. However, incorporating comes with more administrative complexity and maintenance requirements.

Access to capital and fundraising

Partnerships typically rely on partners’ personal assets and bank loans for funding. While some investors may buy into a partnership, options are more limited.

Corporations have a much easier time attracting outside investment. The ability to issue stock options or additional shares of the company can be very attractive for investors.

How to choose between a partnership or corporation

Weighing options like taxes, financing needs, and legal risks can help you decide between structuring as a partnership or corporation.

For hands-on owners who want simplicity and control, a partnership may be a better choice. If you’re planning to scale rapidly or seek outside investment, a corporation often makes more sense.

Consider financing

Partnerships primarily raise money through debt financing or loans. Corporations can much more freely raise investment capital by issuing stock — a major advantage.

As a small business owner, think about your growth plans and how much capital you may require in the next 5-10 years. If you envision needing to raise money from angel investors or venture capital firms in the future to scale, a corporation puts you in a far better position to do so. Partnerships are more constrained in funding options and can’t sell ownership stakes in the business as freely.

Consider legal risk

For small businesses hoping to pursue aggressive growth in the coming years, beginning as a partnership carries some risk. If your vision is to rapidly expand operations and locations across multiple states, a partnership will eventually need restructuring. Most scale-oriented businesses evolve from partnership to corporation over time.

Why? Because at greater size and complexity, corporations offer liability protections and flexible ownership options. Significant growth is often easier under a corporation.

Even if you’re just starting out, it can be advantageous to start out as a corporation. Restructuring from partnership to corporation later on requires formally dissolving the partnership — a potentially cumbersome transition for a large organization.

Consider taxes

Tax treatment also plays a major role in the decision between partnership versus corporation. Partners benefit from pass-through tax and taxes on partnership income at individual rates. This often results in lower total taxes paid than the corporate double tax scenario.

But, corporations can benefit from tax deductions and breaks that partnerships can’t. In some cases, you may be able to access more tax savings with a corporation.

Small business owners should evaluate their expected profit levels and income brackets to figure out which structure works best for them. You may also want to consider local taxes — for example, your state may assess additional taxes or fees on corporations that impact your decision. Consult an accountant to help you find the best solution based on your specific situation.

How Swoop can help

No matter which structure you decide on for your business, it’s important to find financing that supports your growth goals at any phase.

Swoop Funding offers fast, simple financing solutions to fuel your SME’s expanding needs — whether bootstrapping or scaling rapidly. Our online lending platform lets you compare funding offers from multiple business lenders all in one place — saving you time and helping you find the right fit for you.

Swoop Funding can help both partnerships and corporations unlock the necessary growth capital to take your company to the next level. We work with everyone from one-person startups to companies with hundreds of employees.
With Swoop’s growing lender network, you can get matched to financing solutions, whether looking for startup seed funding, SBA loans, equipment financing, merchant cash advances, commercial real estate loans, or more tailored business funding products. Register with Swoop to find the best loan for your business needs, and let us guide you through the application process.