“Working Together” – How to Start and Formalize a Business Partnership
by Caron_Beesley, Community Moderator
- Created: October 19, 2011, 7:46 am
- Updated: March 2, 2012, 4:03 pm
Business partnerships are common among startups and small businesses, and it’s not hard to see why. From an entrepreneurial standpoint the benefits are plentiful. The right business partnership is like a good marriage – not only do you have someone who shares your vision but you also get help with the financial and practical side of business ownership.
This being said, partnerships do have their disadvantages. For example, in a business partnership, individual partners are personally liable for all the business's obligations and debts, as well as decisions made by other partners. And then, of course, there’s always the potential for conflict.
However, with the proper foresight and planning, these disadvantages can be avoided and a sustainable and successful business partnership can be yours.
Here are some tips and considerations for starting and formalizing a business partnership that benefits all involved.
Are You Ready for a Partnership?
Think long and hard about this one. Do you really need a partner? If your partner brings a network, capital, or critical skills you lack then the answer is probably yes. If not, you might want to consider going into business on your own and hiring your prospective partner as a consultant or employee.
Other considerations include: Are your skills complementary? Have you ever worked together before? Are your goals and aspirations aligned?
Form a Legal Partnership Agreement
Once you are ready to go into a partnership you’ll need to lay the ground rules for a successful business relationship in the form of a legal partnership agreement. Think of this as your prenup!
Although it is not a legal requirement, a well thought-out agreement gives you the flexibility to structure your business in a way that suits everyone. This includes how you will share your profits (and losses), who assumes which responsibilities, and so on.
Be sure to work with a lawyer and/or accountant to develop and formalize your agreement. Areas to cover include:
- Name of the partnership – You can either use your own names, for example Hewlett-Packard, or choose to use a fictitious name. If you go the latter route, you’ll need to register a “Doing Business As” name.
- Contributions to the partnership – If you intend to contribute cash, property, or other assets to the business,make sure your contributions, and your ownership percentage, are agreed to and documented before you go into business.
- Compensation – How and when will partners be paid? How will you divide profits and losses?
- How future business decisions are made – 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 – Nothing too ironclad, but it’s worth dividing up who does what (managing the books, overseeing employees, managing payroll, etc.).
Set Up Your Business Correctly
Your next step is to take care of the regulatory and legal steps involved in starting a business. This includes registering your business with your state and getting the right licenses and permits (this handy Business License and Permit Search Tool can quickly help you find what you need). For a quick summary of the steps you need to take to get established correctly take a look at SBA’s 10 Steps to Starting a Business.
Familiarize Yourself with How Partnerships are Taxed
Because the IRS doesn’t consider partnerships to be separate entities from their owners, all profits and losses are passed through to the individual partners. Despite this, your business will still need to file a business tax return (Form 1065). However, 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. Read Making Estimated Tax Payments – A 101 for the Small Business Owner for more information.
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