Selecting a business entity is an important decision in starting a new business.

Before selecting a business entity for a construction company (a corporation, an LLC or a partnership), the intended owner likely met with a lawyer and discussed limiting personal liability, tax consequences and ownership structure. In that conversation, the prospective owner or owners were likely immediately advised against a partnership because it does not provide any limitation on personal liability.

No limitation on personal liability means that if the partnership was responsible for debts it could not pay, the partners would be personally liable for those amounts. That means the partner’s personal assets, home, bank accounts, cars, etc. are all at risk.

But then a big project comes up, and the construction company decides to bid or work on it with another individual or entity. The owner or owners decide to “partner” with that individual or entity or should a joint venture be considered? But what does that mean? And what are the risks involved? It is important to consider why a “partner” relationship could be just as dangerous as organizing an entity as a partnership.

What is a partnership?

The association of two or more people to carry on a for-profit business as co-owners forms a partnership, whether or not the people intend to form a partnership.

How is a partnership different than the existing entity?

Whether a construction company is an LLC, a corporation, an s-corporation, or any other entity, it is different than a partnership for one key reason: a partnership does not have any limits on personal liability. An entity and the person or entity being “partnered” with are personally liable for the debts of the partnership. This includes debts that the “partner” may have negotiated and signed independent of the other partner.

What is a joint venture?

A joint venture is very similar to a partnership. The difference between a partnership and a joint venture is that a joint venture is limited to a specific business objective rather than an ongoing business. The principles of partnership law apply to joint ventures.

What are the rules of a partnership?

Traditionally, partnerships are governed by a partnership agreement. If the parties agree what the rules of the partnership are in advance, and put those rules in writing, those rules govern. But often, decisions to “partner” on a project are not reduced to a written, signed agreement. Instead, the agreement is either verbal, or is only broadly decided on via email, i.e. “We’ll provide the labor, you provide the materials, and we’ll split the profits 60/40.”

This could be dangerous because not all the rules are worked out in the same way they are for an existing entity. For example, who can negotiate and sign change orders? Who is coordinating with the owner or higher tiered contractor? What happens if the project was underbid and there’s a large material overrun?

The default rules of partnerships apply for any terms the partners did not agree on in advance. Some of those default rules include: each partner is entitled to an equal share of the partnership profits and is charged with an equal share of the partnership’s losses in proportion to the partner’s share of the profits and partners have an equal duty to manage the business.

Why should a contractor be careful about “partnering” with another person or business entity for a project?

“Partnering” or forming a joint venture with another entity could lead to incredible success. It could also end in disaster. Before partnering or forming a joint venture with another person or entity, make sure to consider the relationship in the context of the reasons initially decided not to create a partnership for an existing business entity.