Two people sitting at a desk enjoy the benefits of partnership

Partnering to Raise the Capital You Need to Buy a Business

It can be expensive to buy a business. In many cases, the costs are far higher than a person can afford on their own. Many use loans and other financing options to help cover those costs. But they often overlook a simple solution: partnership. In this article, we'll help you understand what a partnership is. But first, let's go into the benefits of a partnership.

 

What are the benefits of partnership?

Partners can offer three forms of capital you need to succeed in your new business:

Intellectual capital

Great partners often have knowledge, experiences, and skills that their counterparts don’t have. As a team, they have a solid understanding of what needs to happen in every part of their business. And together, they excel at executing their plans.

Financial capital

Great partners have access to cash or ways to acquire funding. Specifically, they have good credit scores (at least 650), which is necessary for taking out term loans, asset-backed loans, or SBA loans to finance the acquisition, purchase inventory, or fund the business’s operations.

Human capital

Great partners put in the work that’s needed to make the business a success. Depending on the arrangement, partners may take a hands-on or hands-off approach. In either instance, they’ll contribute when and precisely how they’re needed.

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Should I find a partner to buy a business with?

Maybe. But before you decide, make sure you understand both the pros and cons of this setup.

Let's start with the positives.

Success may come more easily with access to other skills, more knowledge, and more day-to-day support. And, often, partners can help owners access more financial capital, too. If you choose a partner with cash on hand to invest in the business, you can avoid taking on costly loans or leveraging your assets, two options that introduce expense and risk.

Now, the negatives.

Depending on your partnership arrangement, you might not have the autonomy you want to make decisions and execute your ideas—at least, not without talking with your partner first. And while you and your partner will share in the costs, you’ll also share the profits. These could be minimal at the outset.

If you decide to partner, find a person (or people) with the qualities you need to help the business thrive.

 

What should I look for in a partner?

The partner you choose should have skills, experiences, connections, or resources that will benefit your business. You should also be confident in that person’s abilities to team well and execute plans to achieve important goals.

Lots of people who think of partnering bring in a family member or close friend. They do this because they trust their close circle of connections and know their strengths, abilities, and limitations intimately. Others avoid partnering with family or close friends because of the potential for fallout if business decisions go awry.

How should you proceed? Start with a gut check. Gauge your comfort level in working with friends and family. Then, consider partnering with a professional contact you know and can trust. Finally, think about what it would be like to work with people outside your network who can offer valuable skills, resources, and experiences.

 

How do I organize a partnership?

To start, you’ll need to decide which kind of partnership suits your goals or if organizing into another structure makes more sense. Here are some of the options you might consider:

General partnership

A general partnership is a co-ownership arrangement where two or more people both have legal and financial responsibility for the business.

 

How to form it:

  • General partnerships are formed with a partnership agreement. This should be drafted by an attorney and signed by every ownership partner.

 

What's great:

  • Each partner shares in the responsibility of running the business.
  • The partners can pool their strengths, resources, and connections to benefit the business.
  • Partners often have better access to loans with favorable terms because of the strength of their combined credit ratings.
  • Partnerships avoid the double taxation that impacts other ownership arrangements. This is because business profits and losses are reported on the partners’ personal tax returns.
  • The ability to allocate losses to owner partners can increase the business’s internal rate of return on investment. It may also afford the partners some income tax benefits.

 

What you need to think about:

  • Each partner is personally responsible for the business’s taxes, debts, and claims against the partnership.
  • Each partner is liable for other partners’ debts.
  • Creditors can seize any partner’s personal assets to reclaim debts.
  • Each partner can commit the business and other owners to obligations without signed consent.

Limited partnership

A limited partnership is an arrangement that includes one or more general partners with full legal and financial responsibility for the business and one or more partners whose liability is limited to the amount that they invest in the business.

 

How to form it:

  • Like a general partnership, limited partnerships also require a partnership agreement. This should be drafted by an attorney and signed by every ownership partner.

 

What's great:

  • As a general partner, you can raise the capital you need without giving others a say in its daily operations.
  • You can repay the investments your partners make in the business on terms you both agree to rather than at fixed intervals of time.
  • Partnerships avoid the double taxation that impacts other ownership arrangements. This is because business profits and losses are reported on the partners’ personal tax returns.
  • The ability to allocate losses to owner partners can increase the business’s internal rate of return on investment. It may also afford the partners some income tax benefits.

 

What you need to think about:

  • You, as the general partner, are responsible for the entirety of managing the business.
  • You bear full responsibility for the business’s debts, taxes, and claims.
  • Creditors can seize your personal assets to reclaim debts.

C Corporation

A C Corporation (C corp) is a legal structure for businesses with one or more owners. This structure helps shield owners’ personal assets from the business’s debts and financial obligations. Businesses that use this structure have an elected board of directors, adopt bylaws, issue stock, hold shareholder meetings, file annual reports, and pay annual fees related to their formation. They are taxed separately from their owners, and the owners also pay tax on the income they receive from the business.

 

How to form it:

  • Owners file Articles of Incorporation with their state and pay a filing fee.

 

What's great:

  • In many cases, creditors cannot seize your personal assets to reclaim debts.
  • You may offer shares to as many individuals or entities as you like, within and outside the United States.
  • You can offer multiple classes of stock to suit investor preferences.
  • Your company’s shareholders can sell and transfer their shares freely.
  • You may be able to deduct all of your business’s charitable contributions and donations (provided they don’t exceed 10% of your company’s income), as well as some benefits, including health insurance.
  • Recent tax reform policies may allow you to pay a lower corporate tax rate than the maximum rate currently in place for individuals.

 

What you need to think about:

  • The business must pay tax on its earnings and the shareholders must pay tax on their dividends, so earnings are taxed twice.
  • The rules for corporations are strict and complicated.
  • The costs of running a business as a C corp are higher than in some of the other arrangements.
  • Extensive documentation is needed to establish this type of business.

S Corporation

An S Corporation (S corp) is a legal structure that looks a lot like a C corp, but there are two key differences. First, a business organized as an S corp can issue only one class of stock to a limited number of U.S. resident shareholders (presently 100) rather than multiple classes of stock to an unlimited number of shareholders. Second, the S corp itself doesn’t pay tax. Instead, the owners report the business’s revenue as personal revenue.

 

How to form it:

  • Owners file Articles of Incorporation with their state and pay a filing fee. They file Form 2553 with the IRS.

 

What's great:

  • In many cases, creditors cannot seize your personal assets to reclaim business debts.
  • You and other shareholders don’t have to pay a corporate-level income tax.
  • You and other shareholders may be able to deduct up to 20% of your net qualified business income because of the Tax Cuts and Jobs Act (2017).
  • Your business’s losses will pass through to its shareholders. Shareholders may be able to use the losses to offset income.

 

What you need to think about:

  • Because your business is limited to 100 shareholders, you could struggle to raise large amounts of capital.
  • The shareholders of your business cannot be entities, so you can't raise capital from venture capitalists or private equity funds.
  • You'll likely need to limit your shareholders’ ability to sell or transfer their shares to ensure that shares aren’t given to an ineligible shareholder, a move that could terminate your S corp status.
  • Your shareholders will be taxed on the business’s profits, even if income isn’t distributed to them as cash.

Limited liability company

A limited liability company (LLC) combines elements of a partnership and a corporation. Like a partnership, the LLC allows owners to avoid paying income taxes because they report the business’s profits and losses on their personal income tax returns. And, like a corporation, the LLC helps protect owners’ personal assets from the business’s debts and liabilities.

 

How to form it:

  • Owners file Articles of Organization with their state and pay a filing fee.

 

What's great:

  • In many cases, creditors can't seize your personal assets to reclaim business debts.
  • LLCs avoid the double taxation that impacts other ownership arrangements by reporting business profits and losses on the owners’ personal tax returns.
  • The ability to allocate losses to owner partners can increase the business’s internal rate of return on investment. It may also provide owners some income tax benefits.

 

What you need to think about:

  • Your company cannot issue stock.
  • Some small businesses are ineligible to form an LLC. Certain states exclude banking or insurance businesses, accounting firms, architecture firms, and medical practices, among others.

 

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If you see more benefits in a partnership rather than a C corp or S corp arrangement, you’ll need to create a partnership agreement. A partnership agreement, which is often drafted by an attorney, should cover these topics:

  • The name of your business
  • A brief description of its purpose
  • The purpose of your partnership
  • The duration of the partnership
  • The kind and value of the assets each partner will invest
  • The method you will use to share profit and loss
  • The compensation of each party
  • How tangible and intangible assets will be divided if the partnership is dissolved
  • Provisions for dissolving the partnership
  • Provisions for buying and selling stakes in the business, which should include how the business will be valuated
  • The conditions for bringing on new partners
  • How the partners will settle disputes (often arbitration or mediation)
  • How changes to the partnership agreement may be made

 

General partnership agreements can include additional clauses. Sometimes, they spell out the authority each partner has without engaging the other partner(s); the administrative duties of each partner; and any restrictions partners have in engaging in outside business activities.

Limited partnership agreements can include unique clauses, too. Clauses might specify when each partner will receive reports and updates on the business; the conditions for returns; and when and how the general partner may buy out a limited partner.

Would you like to speak with an attorney about forming a partnership? Click the Connect button below to get started:

 

What are my other options for raising capital?

If sharing the ownership of a business doesn’t appeal to you—or if you’d like to consider a partnership with other options—you might consider SBA loans, term loans, asset-backed financing, seller financing, or 401(k) options. This resource will help you work through your options:

 

Looking for support as you buy a business? We can help. Log into your owner’s portal for articles and checklists you can use to make your venture a success.

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