Keep these things in mind before entering a business partnership.
The unprecedented nature of 2020 and the coronavirus pandemic has given many individuals the rare chance to venture into entrepreneurship. Starting a small business allows talented professionals to create offerings and services needed by consumers and explore new career opportunities.
According to The Wall Street Journal, more than 3.2 million applications have been submitted for employer identification numbers (EINs) in 2020. Filing a tax ID typically signifies making significant strides forward in business, as this number is used to open business bank accounts and hire employees. As entrepreneurs file for EINs, they are taking care of other legal aspects of their small businesses, including registering necessary trademarks, obtaining business licenses and incorporating as entity formations.
One business formation that is particularly popular with individuals looking to start a business with someone else is a partnership. Some entrepreneurs may have used time in quarantine to develop a business idea with a partner like a family member or close friend. They may plan to form a partnership for their new venture.
Before you team up, however, there are a few important aspects to keep in mind about business partnerships. Follow these guidelines before getting started.
1. Research different types of partnerships.
Going into business with a partner means understanding the manner in which they would like to run the business, and vice versa. A partnership entity formation comes in several structure options.
A general partnership, the most common type of partnership, establishes an agreement across the partners running a business. All profits, liabilities and management duties are to be divided equally across the partners.
However, there is one downside to a general partnership. This entity is often considered to be unincorporated. It's a bit like a sole proprietorship in that there isn't limited liability protection. In the event business debt incurs, partners do not have a limit on their personal liability for the debts of the business. Partners would need to use their personal assets to repay the debt. Rather than risk this type of liability, partners may incorporate as a different type of partnership, such as a limited liability partnership (LLP). Or, they may choose to incorporate as a limited liability company (LLC).
Joint venture partnership or silent partnership
Joint venture partnerships share most of the same similarities as general partnerships. However, a joint venture partnership differs in that it is temporary. This type of partnership is designed to expire. Typically, it is put into place to speed up certain business processes or when a phase of development is complete.
A silent partnership is designed for partners that wish to be less active in the company. In a silent partnership, one partner is allowed to act as the financial muscle of the business. They help secure capital and make this their primary focus. As such, they do not participate in the company’s daily operations. A different partner assumes this responsibility. Make sure to discuss with your partner beforehand what each individual will be held responsible for in a silent partnership.
Limited liability partnership
A limited liability partnership (LLP) provides businesses with the same limited liability found in a limited liability company (LLC). This protection ensures that personal and professional assets remain separate. The personal belongings of a partner, like houses and cars, would not be used by the partner to repay business debt, for instance.
You may need to determine if your profession allows you to incorporate under an LLP. This partnership structure is reserved for professionals in licensed professions by the state. Think doctors, lawyers, accountants, dentists, pharmacists and psychologists, to name a few licensed professionals.
2. Create a written partnership agreement.
Now that you're familiar with partnership entity structures, it is time to draft a written partnership agreement.
What is a partnership agreement? This is a document that holds each partner accountable for their roles and responsibilities within the partnership. You may already know that you will work together, but what does that work look like? A written partnership agreement outlines the following partnership clauses:
Partnership term. This is the official start date – including the month, day, and year – of the partnership. The partnership is expected to continue indefinitely, unless a termination date is specified otherwise. (A joint venture partnership, for example, would include a specific end date).
Responsibilities. The role that each partner plays in the partnership, as well as their daily responsibilities, is outlined in this section.
Capital. How much capital did each partner contribute to the partnership? State the full amount in this section. Include additional details about how, and when, partners are to be paid, the profit and loss terms for each partner, and the account where the money will be kept.
Admitting new partners. What are the rules for admitting new partners into a partnership? This section outlines the process for admitting new partners and the roles the partners will play in it.
Voluntary/involuntary partner withdrawal. What if a partner leaves the partnership, or involuntarily leaves? What happens next? Terms must be outlined for the withdrawal process. In some cases, this may lead to the dissolution of the partnership.
- Death of a partner. In the event a partner passes away, an agreement must be created that outlines the rights of the surviving partner(s).
Do you need a written partnership agreement, or can you skip drafting this document?
It is highly recommended partners create a written partnership agreement. An oral agreement, which is sometimes used in lieu of a written agreement, may create complications in a partnership. For example, it may become too difficult to recall the exact date when certain terms were put into place.
What if your state of formation inquires into the written partnership agreement? Being unable to produce a written partnership agreement may put your partnership entity into hot water. It may cause your business to lose its credibility and potentially fall into bad standing with the state.
3. Obtain an EIN.
Earlier, I mentioned that more than 3.2 million EIN applications have been filed in 2020. What role does an EIN play in the success of a business partnership?
The IRS issues EINs to help identify the employer tax account of businesses. Many business owners use their Social Security number on business documents. In a partnership, however, this is not feasible. A partnership includes at least two partners, or owners. Therefore, an EIN must be used and applied for by at least one partner prior to launching a partnership.
Over time, you may make small changes within your partnership. Amendments may be made to the written partnership agreement, new partners may be admitted, and the business itself may head into new and exciting directions. Discuss it all with your partner. Review and vote together on everything before moving forward – and enjoy the teamwork that being in a partnership brings you and your partner in business.