Two professions form a partnership to start a business.

Tips for Forming a Partnership to Start a Business

It can be expensive to start a new business. Fortunately, there are lots of financing options that can help you take on those costs. Most think about loans, leases, or leveraging their personal assets to come up with the cash they need to start a business and build up some liquidity. But one option that's often overlooked is a partnership. Read on to learn whether partnership could be a good choice for you as you start your business.

 

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 know-how, 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. They also excel at executing their plans.

Financial capital

Great partners have access to cash or ways to acquire funding. They have a good credit score (at least 650), which is often a must for taking out term loans, asset-backed loans, or SBA loans to cover startup costs, buy inventory, or fund the business’s operations.

Human capital

Great partners are willing to 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’re willing to pitch in when and how they’re needed.

Is a partner right for me?

Maybe, but before you decide, you'll need to study the pros and cons of this setup.

There are advantages to having access to more skills, knowledge, and support as you begin running your business. There are benefits to accessing more financial capital, too. If you choose a partner who has 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.

But there are some downsides to partnership, too. Depending on your arrangement, you may 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, which could be minimal at first.

If you decide to go forward with a partnership, try to find partners with the traits your business needs to thrive.

 

What should I look for in a partner?

The ideal partner should have skills, experiences, connections, or resources that will help your business. You should be confident in that person’s abilities to team well and act on plans to achieve key goals.

Anyone can have these traits. It could be someone you're vaguely familiar with. It could be one or more of your close professional contacts. And often, people choose family members or close friends to partner with them in the early stages of startup. This last choice comes with some risks. Some people avoid partnering with family members or close friends. This is often because relationships can sour when people don't agree on paths forward. Others prefer to partner with people in their closest circle of connections because they trust one another and know each other’s strengths, abilities, and limitations well. You'll need to take stock of who you want to work with, always prioritizing people with the right sets of skills, resources, and experiences.

 

How do I organize a partnership?

To start, you’ll need to decide whether you want to form a general partnership, a limited partnership, a C Corporation, an S Corporation, or a limited liability company. Some of these arrangements aren’t technically partnerships. Instead, they’re methods you can use to organize a business with multiple investors.

Here, you can learn about each type of arrangement and its pros and cons:

General partnership

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

 

How to form one:

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

 

What's great about this option:

  • Each partner shares the responsibility of running the business.
  • The partners can pool their strengths, resources, and connections to benefit the business.
  • It’s possible that the partners would 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 by reporting business profits and losses on their 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.

 

The drawbacks:

  • Each partner is personally responsible for the business’s taxes, debts, and claims against the partnership.
  • Each partner is liable for other partner(s)’ 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 at least two people or entities. One or more is a general partner with full legal and financial responsibility for the business. The others have liability that's limited to the amount they invest in the business.

 

How to form one:

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

 

What's great about this option:

  • 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 (such as when the business has a certain amount of excess profits) rather than at fixed intervals of time.
  • Partnerships avoid the double taxation that impacts other setups by reporting business profits and losses on their 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.

 

The drawbacks:

  • 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 the business’s debts.

C Corporation

A C Corporation (C corp) is a legal structure for businesses with one or more owners. Through this structure, owners’ personal assets are typically shielded 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. The owners also pay tax on the income they receive from the business.

 

How to form one:

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

 

What's great about this option:

  • 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, and they do not have to reside in the US.
  • 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 that 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 that’s currently in place for individuals.

 

The drawbacks:

  • Because the business must pay tax on its earnings and the shareholders must pay tax on their dividends, the corporation’s 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 shares many similarities with the C corp. However, 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 one:

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

 

What's great about this option:

  • 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.
  • Because of the Tax Cuts and Jobs Act (2017), you and other shareholders may be able to deduct up to 20% of your net qualified business income.
  • Your business’s losses will pass through to its shareholders, who may be able to use the losses to offset income.

 

The drawbacks:

  • Because your business is limited to 100 shareholders, you may have difficulty raising large amounts of capital.
  • The shareholders of your business cannot be entities, so you won’t be able to raise capital from venture capitalists or private equity funds.
  • You will 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 one:

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

 

What's great about this option:

  • In many cases, creditors cannot 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 their 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 owners some income tax benefits.

 

The drawbacks:

  • 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.

If you decide on a partnership rather than a C corp or S corp arrangement, you’ll need to create a partnership agreement. This agreement, which is often drafted by an attorney, often includes these elements:

  • 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
  • How you'll share profit and loss
  • The pay structure for each party
  • How the business’s tangible and intangible assets will be divided if the partnership is dissolved
  • Provisions for the dissolution
  • 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 agreement may be made

 

General partnership agreements may also include clauses that explain each party's authority (without engaging the other partner(s)), administrative responsibilities, and restrictions in engaging in outside business activities.

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

Would you like to speak with an attorney about forming a partnership to start a business? 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 partnership with other options—look into SBA loans, term loans, asset-backed financing, 401(k) options, portfolio loans, and other options such as angel investors and venture capital. You can learn more about these options here:

 

Starting a business is a complicated process. We have resources that can help you with every action you need to take. Log into your owner’s portal for a free step-by-step guide to make your venture a success.

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