Could two heads be better than one for your small business?
Partnerships can benefit start-ups and growing business in many ways – shared risk, access to funds and expertise, and the sharing of duties. Of course, partnerships can be risky. One partner may not pull their weight, financial wrangling adds fuel to the fire, and ultimately the relationship and agreement sours.
Entering into a business partnership is a big commitment and upfront planning is a must.
Here are six things you should do before you enter into a business partnership.
Weigh the pros and cons
Aside from the generalized advantages and disadvantages mentioned above, spend some time weighing up the pros and cons relative to your business, industry, personality and finances.
What are you seeking in a partner? Is it network, capital or critical skills that you lack? If you have someone lined up who can contribute to these, then a partnership can make sense. If you not, then consider forming the business yourself and hire someone or find a mentor who can bring these assets to the table.
Get to know your partner first
If you have a partner in mind, how much do you know about them (third-party investigative services can even help out with this by running background checks on individuals to help assess risk)? Have you ever worked with them before? Do you both want the same thing out of business? Do they exemplify your brand?
What about your skills – are they complementary? This is very important as you start to determine who does what in the partnership, both at a strategic and day-to-day level.
Understand the different forms of legal partnership
Each state has specific laws on the formation and dissolution of business partnerships as well as laws regarding the legal responsibilities of each partner. There are three forms of legal partnerships that business owners can consider:
- General partnership – The simplest route and similar to a sole proprietorship. Just register your “doing business as” name or trade name and open a bank account in your business name. In this structure, all profits, liability and management duties are split equally (any variation from this needs to be outlined in the partnerships agreement).
- Limited Liability Partnership (LLP) – If you’re looking for more legal protection, an LLP can help. Much like an LLC, this option affords partners protection from personal liability for the debts and liabilities incurred by the business.
- Limited Partnership – In this scenario, one partner may invest in the partnership, but not contribute to the day-to-day management.
Find more detailed information about types of partnership here.
Taxation and partnerships
The IRS doesn’t consider partnerships to be separate entities from their owners, and all profits and losses are passed through to the individual partners. However, your business will still need to file a business tax return (Form 1065), but it won’t pay income tax on the profits and losses disclosed. Instead, each partner will need to file an annual tax return showing their individual shares of the company’s profits and losses – and the amount of tax owed. This tax is actually paid each quarter in the form of estimated taxes to both the IRS and your state.
Decide how you’ll split profits
How you split the profits is up to you. Bear in mind that if you stick with a clean 50-50 split, neither partner can make any business decisions autonomously; each party must agree. Whereas a 49-51 ratio gives one party the final authority to end deadlock on business decisions. Another option involves each partner taking a salary and then splitting the remaining profits between you. This is a useful approach if it’s already agreed that one partner will play a more active role in the business.
Set it all in stone – the partnership agreement
The best way to protect yourself in any partnership is to form a partnership or operating agreement. Though not a legal requirement, think of the agreement as your prenup! This is where you’ll outline how profits will be split, who assumes responsibilities and so on.
Any issues that could arise between partners should be able to be resolved by referring to the agreement that you collaborated on to create. If you find yourself unhappy in your partnership, your operating agreement will be one of your best chances to prove resolution. If you don't provide a custom agreement, you'll be defaulted to your state's generic version, which will most likely not cover the intricacies of your business.
Work with your lawyer and accountant to formalize your agreement. At a minimum include the following:
- Division of profits and compensation – Don’t forget to include how you’ll handle losses as well as profits.
- Contributions to the partnership – These include any assets, property or cash that either partner rolls into the business.
- Decision-making – This includes the scope of an individual partner’s authority to make decisions, how you’ll handle disputes, on-boarding new partners and how the partnership will be dissolved.
- Management duties – Although there needs to be room for flexibility here (for example, if one partner is sick the other should be prepared to step in and help out), document the key functions performed by each partner. For instance, if you prefer to handle employee relations or payroll, state that here so that there’s no confusion down the line.
The bottom line
Partnerships are a popular choice for small businesses. According to the latest data from the SBA Office of Advocacy, partnerships and sole proprietors constituted 94 percent of non-employers in 2010. However, as with any business undertaking, it’s not without risk. Do your research upfront, weigh up the pros and cons and protect yourself with an ironclad agreement.