You’ve heard the phrase “two heads are better than one” and that often rings true for entrepreneurs. Along with the pooled knowledge from multiple brains, having a business partner brings the perks of additional funds, a wider breadth of skills, a built-in support system, and another set of hands to handle tasks. I know a thing or two about all that because I started CorpNet with my business partner and husband, Phil. While not all business partnerships involve spouses, many of the same considerations come into play when contemplating how to start a business with a partner.
A Few Things to Consider
Consider using the checklist below as a litmus test for determining if you and your partner are a good match and have the collective mindset to make it work successfully.
Do You Have Shared Values?
The personal values of business owners influence their company’s values. While partners cannot expect to agree on everything, they should at least have a unified set of core values (guiding principles and beliefs). That will serve to create a consistent company culture at the leadership level and throughout the organization as it grows. Some things partners should talk about include viewpoints on eco-friendliness (a.k.a. environmental sustainability), commitment to customer service, involvement in giving back to the community, and other important concepts that could create confusion if partners aren’t on the same page.
Having a conversation about values before going into business together will give you a head start on defining your company’s core values as you prepare to launch.
Do You Have a Shared Vision?
Do you and your prospective business partner have the same expectations for what you want the business to achieve? A shared vision sets a firm foundation for a successful partnership. Ask yourselves some questions to see if you’re aligned on your short-term and long-term view of what your company will be.
- Do you wish to cater to a local target market or expand across your state, the country, or beyond?
- What do you want your company to mean to your customers?
- Do you expect to operate the day-to-day operations yourselves or delegate those duties to someone else?
- How large do you wish to grow your business?
Do You Complement Each Other?
One thing that makes Phil and I good business partners is that we each possess different strengths. While much of our business acumen is similar, we have our own specific competencies that, when combined, create a well-rounded entrepreneurial team.
I believe it’s vital that prospective business partners carefully assess their skills and knowledge to determine what each brings to the table. This can also help identify what outside help is needed from employees, vendors, or professional services providers to handle the many aspects of starting and managing the business.
Do You Agree on Roles and Responsibilities?
After assessing collective strengths, aspiring partners must agree on their roles and responsibilities in the company.
- How much money will each personally invest in the business?
- How much time will each spend working on and in the business?
- What decision-making authority will each partner have?
- Who is responsible for managing the accounting, sales, marketing, hiring, customer service, and other facets of running the business?
4 Steps for Starting a Partnership
After individuals determine they will make compatible co-owners, they can embark on the actual steps to starting their business partnership.
1. Choose a Business Entity Type
This decision affects a company in significant ways — legally, financially, administratively, and operationally. Several options exist for setting up a business with multiple owners and I’ve listed the most popular below. Note that the available business entity selections may differ from one state to another. It’s advisable for business partners to talk with an attorney and accountant (or another tax expert) for insight into which entity option will prove most beneficial for their unique situation.
Partnerships often begin as a general partnership because the business structure requires no formation filing with the state. There may still be other filings to complete, though. For example, general partnerships must file for a fictitious name (DBA) if using a business name that does not contain the partners’ last names. Also, they will need an EIN (Employer Identification Number) from the IRS if hiring employees or their financial institution requires one to set up a business bank account. And depending on the type of business and where it’s located, a general partnership may need business licenses, tax registrations, and permits to operate legally.
A general partnership is considered the same legal and tax-paying entity as its owners. One disadvantage of the structure is the owners are wholly responsible for the business’s financial and legal liabilities.
Tax filings for a general partnership are relatively simple. The business’s income and losses pass through to the individual partners, who must report them on their personal tax returns and pay taxes at the applicable individual tax rates. In addition to income tax, partners must also pay self-employment tax (Social Security and Medicare taxes) on their taxable income.
In a Limited Partnership (LP), one or more partners assume unlimited liability (i.e., that individual is treated as a general partner). If someone sues the LP, the general partner’s personal assets may be taken to settle debts since there is no legal separation between that partner and the business. The other partners have limited liability (only up to the amount of their financial contribution to fund the company) for the business’s debts.
An LP’s Income taxes are on a pass-through basis, with profits and losses flowing to the partners’ personal tax returns. General partners must pay self-employment taxes on their taxable income from the business. Limited partners may not have to pay Medicare and Social Security taxes on their business income if they are not actively working in the business. According to the IRS, “ Limited partners don’t pay self-employment tax on their distributive share of partnership income, but do pay self-employment tax on guaranteed payments.”
Business owners may find the LP structure attractive if each partner’s involvement in the company is significantly different. For instance, say one partner is financially contributing only (a silent partner) while the other is taking on the day-to-day activities and decision-making for the business.
Generally, partners must enter into a partnership agreement and file a certificate of formation with the state to form a Limited Partnership. Other requirements like an EIN, business licenses and permits, etc. must also be fulfilled.
Limited Liability Partnership
A Limited Liability Partnership (LLP) limits each partner’s liability to the amount of their financial contribution to the business. Different states have different rules about what liability protection applies. Under most circumstances, partners are protected from all the company’s legal issues and debts, except for those caused by their own negligence or malpractice. Other states consider partners personally liable for certain types of debts (e.g., loans).
An LLP has pass-through taxation. Profits and losses flow through to the individual partners’ personal tax returns.
Business owners must file a Certificate of Limited Liability Partnership (called a Certificate of Registration as a Limited Liability Partnership in some states) to form an LLP. States also vary in their rules for who may form an LLP. Some states only allow professionals (for example accountants, attorneys, engineers) in specific industries to operate as an LLP. Others don’t recognize the LLP business structure at all.
Limited Liability Company
A Limited Liability Company (LLC) is an independent business entity separate from its owners (members) legally. So, it offers its members personal liability protection.
It, too, is a pass-through entity, with all income and losses flowing through to each member’s personal income tax return. All LLC members must pay self-employment taxes, too. If an LLC meets the IRS’s eligibility requirements, it may elect for S Corporation tax treatment. Operating as an S Corp is more complicated administratively than an LLC, but it can help reduce the members’ personal Medicare and Social Security tax burden.
To form an LLC, business owners must complete a filing called Articles of Organization (sometimes called Certificate of Organization) with the state.
Setting up a company as a C Corporation creates the most separation between a business and its owners (shareholders). A C Corporation is its own legal and tax-filing entity. Business profits and losses are reported on corporate income tax returns, and the corporation pays those taxes directly. Business partners who work in the corporation get paid as employees. From their paychecks or direct deposits, income taxes and half of their required Social Security and Medicare taxes are withheld. The corporation pays the other half of the Social Security and Medicare taxes (called FICA on pay stubs).
In addition to receiving paychecks, a corporation’s business partners may also be paid dividends (distributions from company profits based on shares of ownership). Dividends are not subject to FICA tax.
While wages and salaries are tax-deductible for the corporation, dividends are not. So, any business profit paid out as dividends will get taxed to the corporation at the corporate tax rates and then taxed again when distributed to the business partners and other shareholders.
Business partners in a corporation report their income, such as wages or salaries and dividends, on their personal tax returns.
Like LLCs, C Corporations may elect for S Corporation taxation if they meet the IRS’s criteria.
Incorporating a business involves filing a form called Articles of Incorporation (some states call it Certificate of Incorporation). States often require other formalities such as bylaws and initial reports when setting up a C Corporation.
2. Create a Legal Agreement
People who enter into business together can benefit from having a legal agreement to document important details. What the agreement is called and what it includes depends on the entity type.
- Partnership Agreement for general partnerships, limited partnerships, and limited liability partnerships
- LLC Operating Agreement for Limited Liability Companies
- Bylaws (founder’s agreement) for Corporations
Because these agreements are legally binding documents, it’s helpful to have an attorney involved in creating or reviewing them. Businesses do not typically have to submit their internal agreements with the state, but owners should keep them at a principal place of business along with other critical company records.
Examples of Information Included in a Business Owners’ Agreement
- Roles and responsibilities of business partners
- Ownership percentages
- How profits will be distributed
- How partners will get paid
- Decision-making authority
- Management structure
- Dispute resolution process
- What happens if a partner leaves
- Dissolution procedures
3. Complete Core Startup Tasks
Business partners have other startup responsibilities, too. The requirements vary by state and business entity type. I’ve listed some of the most common obligations below.
- Get an EIN
- Designate a registered agent
- Appoint a board of directors (corporations)
- Submit an Initial Report
- File a DBA
- Apply for business licenses
- Register for payroll taxes
- Register for sales and use tax
4. Stay On Top of Compliance Responsibilities
Business owners should research the ongoing business compliance tasks they must keep on their radar. These, too, vary depending on the state and business structure.
- File an Annual Report
- Hold board of directors meetings and record meeting minutes
- Hold shareholders’ meetings and record meeting minutes
- Renew business licenses and permits
- Report and pay payroll withholdings
- File Articles of Amendment if making significant changes to the business (e.g., business name, address, director or members, commercial activities, etc.)
If a company fails to complete its compliance obligations, it can potentially face fines and other penalties. And business owners who have opted for an entity type that limits their personal liability risk losing that legal protection.
What is the Best Way to Get Started?
Make sure you and your partner enter into the venture feeling confident you are compatible and knowing what you must do to start and operate your business legally. I highly recommend talking with trusted, licensed legal and tax professionals to gain valuable insight. And when you’re ready to begin tackling your important business filings and applications, ask my team at CorpNet to handle them for you.