The decision to partner with someone in a business is a big one. You want to learn about the person’s background as much as you can, in all ways. For example, you want to learn about your potential business partner’s previous experience, education, and finances. You want to learn more about how they’ve managed past businesses, if relevant, and whether or not they’ve ever dealt with financial difficulties that could carry over to your business.
You also want to make sure when you partner with someone that they’re a person you feel like you match well with. You’re going to be making big decisions together. While it can be advantageous to each have unique viewpoints and experiences you bring to the table, you want to be generally compatible with one another and have a similar view on the path forward.
The following is a guide to the basic things to know about business partnerships and how to set one up.
What Is a Partnership?
In business, a partnership can include two or more parties. You make an agreement about how you’re going to operate your business. You’re organizing a company in a way that’s owned and sometimes may also be run by two or more people or entities, and the partners then also share in profits and losses.
You can form this legal relationship through a written agreement. Partners invest money in the business, and again, the partners will benefit from profits but also have to shoulder any losses.
A partnership usually registers in all the states where it’s going to do business, with every state having different types of partnerships you can form.
Sometimes partnerships include people who work in the business, or they can include partners with limited participation. There can also be partners with limited liability for debts the business has and any lawsuits that may be filed against it.
When you’re in a business partnership, it’s not a separate entity from the individual owners, which is one way it contrasts with a corporation. These business entities are more like working as a sole proprietor or independent contractor since the business isn’t separate from the individual for reasons of liability.
The partnership itself isn’t responsible for paying income tax. Profits and losses are divided among partners, and then each will pay income tax based on their individual tax return.
There are three types of partnerships most often set up.
The first is a general partnership, which is a situation where the partners participate in the day-to-day operations of running their business. They have liability as owners for lawsuits and debts under this situation.
In a limited partnership, there is at least one general partner. This general partner manages the business and takes on the liability for the decisions. Then, there’s at least one limited partner who doesn’t participate in business operations and doesn’t have liability.
A limited liability partnership provides legal protection from liability to all the partners. These might be formed by partners who work in the same professional category, such as lawyers and accountants.
There are partners who can be individuals, groups, companies, and corporations. There can also be junior and senior partners.
Partnerships are different from a limited liability company (LLC) because, in an LLC, the members are often shielded from personal liability for the company. Alternatively, in most partnerships, only the limited partners are protected from personal liability for the business.
Forming a Partnership
The following are some of the general steps to take when forming a partnership:
- Choose your partners. This is discussed in more detail below, but broadly, you want to make sure you’re looking at the skills and strengths of your partner, their credibility, and their knowledge. You want someone who’s going to bring resources to the partnership. Don’t rush into choosing someone. Think about whether you share the same values and what they’re going to bring to the table.
- Figure out the type of partnership you’re going to form, each of which has its own pros and cons.
- Create a name for the partnership and once you have one, make sure it’s not already taken.
- Register your partnership with your state and any states where you’re going to do business. You can usually register your business online by going to the Secretary of State’s website.
- Figure out what your tax obligations will be. You will have to handle business taxes as part of your responsibilities as a co-owner of a partnership. Every business entity has to file and pay taxes regularly.
- Apply for an EIN and tax ID. An EIN is an Employer Identification Number.
- Create a partnership agreement. Your agreement should define roles and responsibilities, as well as liabilities. This will be a legally binding contract. If you face conflicts or issues in your partnership, your agreement should be detailed enough that you can refer to it to help solve the problems you’re having. You aren’t technically required to create a partnership agreement, but not doing so can be a mistake.
- Get any needed licenses and permits. You need to check state and local requirements to know exactly what you need. Some of the types of permits and licenses you could be required to get include a resale certificate, sales tax permit, and business license.
- Open a business bank account. You never want to mix business and personal money, creating confusion and potentially financial or legal issues. You’ll need your EIN, partnership agreement, and business name filing document to open a business bank account. Your bank might also require more information and documents.
Other considerations when you’re setting up a partnership might include:
- What will partner roles be in signing and authorizations? You need to have a clear understanding of what the people involved in the business are authorized to do on its behalf.
- What are the particular duties and responsibilities each partner is expected to fulfill? What are the consequences if duties aren’t fulfilled?
- Think about capital contributions. What amount of money, time, or other assets will each partner be contributing? This will include initial contributions and also anything that could be needed to keep the business operating in the future.
- What are the rights to distributions, compensation, losses, and profits?
- Which decisions are going to require a unanimous vote of the partners?
- As you’re creating your partnership agreement, you need to include the events on which you’ll dissolve the partnership. Exit strategies need to be included as much as possible.
- You should also include a buy-sell provision or agreement. For example, what if one partner has to leave involuntarily? How are they bought out? What if you want to sell your interest? Does your partner have the first right to buy you out? What if one partner dies, or there’s a divorce? What about retirement or bankruptcy? Try to cover these what-ifs as much as you can.
- Some partners will include an expulsion provision in their partnership agreement. This is when you might put in writing when partners can be forced out of business.
- You might include a non-compete so that if someone leaves the business, they can’t open one that would be competing or go to work for a competitor for a certain amount of time.
Vetting a Business Partner
Finally, your business’s success or failure is going to depend a great deal on the partner you choose and the relationship you have with that person. Before you get into this life-changing relationship with someone, you should have a strategic plan in mind. This helps guide the type of person you want to work with. You want to know your vision and mission and your own strengths and weaknesses. You should also have an overview of your long-term goals. Once you feel comfortable with your own plan, then you will have something you’ll be able to present to potential partners to make sure they’re on a similar page.
You can review potential partners’ resumes as well. Their resume will help you see not only their work history but some of the things they consider their biggest accomplishments. You also want to learn more about someone’s weaknesses because hopefully, your strengths will account for these and vice versa.
Get to know a possible business partner on a deeper level so that you can gain insight into what their values are. Their personality is important, as much as we might not think business is personal.
Avoid someone who’s always speaking about themselves as a victim. If a potential partner constantly seems to have an excuse as to what things happen “to” them, they’re not the right person. You want a partner who’s willing to accept responsibility and learn from challenges and setbacks.
During this time, don’t share anything without having someone sign an NDA beforehand. This needs to be in place before you talk about even the simplest of details regarding your business. If you don’t use an NDA and you share something proprietary with would-be partners, they have every right to share it.