partnership without informing or getting the approval of her other partner.
Louise wanted to announce their grand opening by placing an ad in the newspaper. Because they were a new business, the paper wanted a check up front. When Louise went to write a check it hit her. They were out of money. Maxine had spent Louise’s entire $10,000, and then some, to open the store.
When Louise confronted Maxine with this Maxine was unconcerned. She asked Louise if she could put up any more cash. But Louise did not have any more money. Her life savings, her dream of her own business and control of her future, was the $10,000 that Maxine had already spent.
Maxine said she did not have a credit card but asked if Louise had or could get a credit card to help them get over this hump. Maxine said that if they could just get the doors open together they would be rolling in profits. It was with this comment that Louise realized that she was putting up all the money and taking all the risk so that Maxine could share in all the profits.
Louise was shaken by this realization but remained composed. She said she did not have a credit card nor did she have good enough credit to get one.
At this, Maxine flew off the handle. She said that she had invested all her ideas of style and atmosphere into the business. All Louise had to do was put up the money. She was furious that her creative vision for L&M Gifts was to be dimmed by Louise’s refusal to put in more money.
Louise was stunned by her partner’s reaction. She had put her life savings into the business. Maxine, without telling her, had squandered it. And now Maxine was angry that she could not put in more.
As one would expect, things soured very quickly between the two. As soon as Maxine learned that no more money was forthcoming, she reignited a relationship with an old boyfriend who lived two thousand miles away. She picked up and left town within forty-eight hours. No one heard from her again.
Louise was left with all the bills. Because Maxine had obligated the partnership, even though Louise had no knowledge of such obligations, Louise as the remaining general partner was personally responsible.
The landlord, the contractor who did the tenant improvements, and the suppliers of the inventory all sued Louise. While Maxine was equally responsible (if not more so) for these debts, the creditors did not even bother to pursue her. She had no money and she was on the other side of the country. Why would someone spend the time and money to chase her? The sole burden of the partnership’s debts fell upon Louise.
Other General Partnership Disadvantages
As if all of the risk and double the exposure were not bad enough, there are other disadvantages to operating as a general partnership:
• Termination. A partnership terminates when one partner dies, leaves, or goes bankrupt. You may be surprised by some unexpected event.
• Sale. Most sophisticated buyers do not want the risk of being in a general partnership. This will hinder the ability to sell your interest in a general partnership.
• Self-employment taxes. We will be discussing those darn Social Security and Medicare taxes throughout this book. Please note here that all general partners (even those not considered employees of the partnership) must pay self-employment taxes on their share of partnership income. Several good entities ahead offer ways to reduce such taxes.
With her life savings gone and her vision of her own business dashed, Louise unhappily went back to work at the department store.
As Case No. 2 illustrates, with a general partnership you have double the exposure of a sole proprietorship. Not only you—but your partner—can put your personal assets at risk. All of the risk and double (or triple or more depending on the number of general partners you have) the exposure is not a good way to do business.
As our first two cases point out, it is important to select the correct entity at the start. (And, please note, not all of our stories will be so dire. It is just that right now we are dealing with bad entities.)
Rich Dad Tips
• The longer you operate as a sole proprietorship or general partnership the longer you are going to be personally responsible for every bad thing that can happen in your business.
• If you are currently operating as a sole proprietorship or general partnership, see a professional or visit www.corporatedirect.com about switching to a good entity.
• If you are considering getting into a business, do not start out on the wrong foot by using a bad entity.
To succeed in business, to protect your assets and to limit your liability, you want to select from one of the good entities, structures that are truly separate legal beings. They are:
• C corporations
• S corporations
• Limited liability companies (LLCs)
• Limited partnerships (LPs)
Each one has its own advantages and specific uses. Each one is utilized by the rich and the knowledgeable in their business and personal financial affairs. And, depending on your state’s fees, each one can be formed for $800 or less so that you can achieve the same benefits and protections that sophisticated business people have enjoyed for centuries. But beware of promoters claiming they can incorporate you for $99 or less. We will discuss the consequences of using such services in Chapter 18.
Before we discuss the relative strengths of corporations, LLCs, and LPs, it is important to know the language of each. While their basic structure is similar, the terms for each structural facet are different. Here then is the language for the good entities.
Corporations
The best place to start the discussion of good entities is with corporations. They have evolved over the last five hundred years to become the most commonly used entity for conducting business.
As Robert Kiyosaki learned during his study of admiralty law, corporations came into common usage in the 1500s to protect investors in maritime ventures. Prior to the popular use of corporations, investors would come together as a partnership, outfit a ship, and send it out for trading purposes. If the ship was lost at sea, the investors could not only lose everything but also be personally sued by various creditors. Of course, this exposure deterred people from risk taking and discouraged economic activity. Seeing this, the English Crown and courts allowed for the
