Just like marriages, business partnerships often run into rough waters. To ensure your partnership stays on course, follow these tips.
Finding and adding a business partner to an existing company is about more than going into business with a friend or family member. How you add a partner typically hinges on your business entity. Depending on how you incorporated your business, entrepreneurs will need to conduct a bit of due diligence in order to properly bring on a business partner.
From an LLC to a general partnership, let’s break down what you need to do now to prepare to add a partner to your business.
1. Create a written partnership agreement
One of the most common mistakes entrepreneurs make, regardless of entity type, is the assumption that their business does not need certain written documents. Technically, your business is not legally required to have a partnership agreement. Many entrepreneurs may skip drafting one because it’s a time-consuming process. After all, why do you need a partnership agreement? You already know what your business partner is like and can count on them to always agree with you — right?
Not exactly. Think of your partnership agreement as a document that works with you and your partner. These agreements lay out the partnership’s terms and conditions for each owner of the business. A few terms that are commonly covered include the following:
- Operation roles and responsibilities. Partners clearly understand their daily duties. Additional clauses detail how the partners make decisions and resolve disputes together.
- Partnership terms. The official start date of the partnership, as well as guidelines for termination.
- Admitting new partners. There may come a time when you’ll add even more partners to your business. Be prepared with terms outlining how they will each be admitted accordingly.
- Partner exits. These terms detail what should happen next if a partner voluntarily (or involuntarily) exits the business. Additionally, if a partner passes away there should be guidelines for the surviving partner’s rights in the business.
Once this has been written — and it must be a written partnership agreement, to literally keep everyone on the same page — review the materials alongside your partner with an attorney or legal professional.
2. File for an EIN
If you have incorporated as a sole proprietorship, you have established yourself as the sole owner of the business. Unlike most entities, this formation does not provide businesses with liability protection. That means that the owner is responsible for any unforeseen circumstances that may impact the company. Subsequently, they are unable to receive liability protection to separate personal and professional assets.
The process for bringing on a business partner as a sole proprietor, however, is fairly straightforward. If you do not already have it, file for an employer identification number (EIN). An EIN is a federal tax ID that allows the IRS to identify your employer's tax account.
Why do you need an EIN? There are now two owners of the business instead of one. One owner could previously use their social security number (SSN) on business paperwork. However, you cannot use your personal SSN when there is a second partner involved in the business.
Additionally, the sole proprietor must use Form 1065 U.S. Return of Partnership Income to report the business’s earnings and losses. Individual Schedule K-1s must also be filed in order to cover each partner’s portion.
3. Amend an LLC operating agreement
Businesses that have incorporated as a limited liability company (LLC) draft operating agreements for their companies. Essentially, this document details how the company is run by an LLC’s members, their percentage of ownership, and rights and responsibilities.
Naturally, quite a bit of these rules change once a new partner is admitted into a business. This is especially true if you have been running the business as a single-member LLC (which only has one member). An LLC operating agreement must be amended to reflect changes for the incoming partner.
If you currently run a single-member LLC, the LLC operating agreement will likely need only a few amendments made to it. Detail what the new responsibilities of the member will be, as well as their compensation and the specific amount of capital they have invested into the LLC.
In addition to amending an LLC operating agreement, it’s also wise to check in with the Secretary of State. They will let you know if your business needs to take care of anything else. For example, you may need to file specific tax forms since you are no longer a single-member LLC and will not be taxed as a sole proprietor. You will also need to account for your new member when filing your annual report.
4. Ask yourself: is this the right partner for my business?
As much as you may like someone personally, you have to consider first and foremost if the partnership is good for the business. Will this person be the salt to your pepper or the Ben to your Jerry?
What is often left unspoken about partnerships is that both partners do not need to be carbon copies of one another. Successful partnerships are built on balancing one another’s strengths and weaknesses. If you feel hesitant, for whatever reason, about the person you’re considering partnering with, do not shrug off that feeling. Meet with your mentor or a legal professional to discuss your plan to add a partner to your business and take in their feedback about whether or not this decision is best for — who, again? — the business.
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Funded, in part, through a Cooperative Agreement with the U.S. Small Business Administration. All opinions, and/or recommendations expressed herein are those of the author(s) and do not necessarily reflect the views of the SBA.