A partnership is a legal entity where two (or more) people run a business. Like a sole proprietorship, each partner owns a portion of the assets and liabilities of the business. The main difference is that a partnership relies on an agreement between the partners. This document, the partnership agreement, details ownership and responsibilities.
Starting a Partnership
Creating the partnership agreement is the most important step. It will lay out the relationship between the parties. For a general partnership (see Limited Liability Partnership for another type) this will shape many aspects of the business.
Some things included in a basic agreement:
- Business Name – More important here than in a sole proprietorship because partners will often share business accounts and act in the name of the business.
- Contributions – Each partner’s stake in the formation and ongoing finances of the business must be clearly laid out. How much will each put into the pot? What about future obligations?
- Distributions – How will profits be split between partners? Who gets paid first and how much?
- Ownership – Who gets what if the business is sold? What happens if one partner wants to withdraw? What about taking on new partners? What are the options for buying out another partner?
- Decision Making – Who gets the last say? What about day-to-day management decisions?
- Disputes – How will disputes be handled? Is binding arbitration a good option or will things have to go to court? Does a ‘silent partner’ have a say in business operations?
- Critical Developments – What happens if one partner gets sick or dies? How will the business be evaluated (and what is the split) if a buy-out offer comes in? What provisions will be used for retirement? Under what circumstances can the partnership agreement be modified, and how?
These are the most common issues. You should see immediately one of the downsides of a partnership – a substantial difference of opinion between partners. What starts out as a wonderful relationship can change into a phenomenal burden over time and under the stress of doing business.
The best recommendation is to get help when drawing up a partnership agreement. Make sure each party fully understands the conditions and include as much detail as possible. It is a wise practice to consult an attorney to ‘vet’ the agreement and point out weaknesses.
Partnerships keep the same tax benefits as sole proprietorships. The tax rate is based on income from the business as personal income. The term for this is pass through. That is, the tax obligation passes through the business to the owners. One difference may be that a partner who doesn’t pay his taxes might accrue a debt with the IRS – making other partners liable. Although the business assets are the actual target of the IRS, these are spread out to other partners and the obligation can pass through to the other owners.
Partners are jointly and severally liable. When the business gets sued, each partner can be drawn into the case. A judgment will apply to all concerned parties. Just as the taxes pass through, so do the liabilities.
Like a sole proprietorship, this is considered a major disadvantage of a general partnership. There are thousands of examples of one partner acting unethically or even criminally and drawing an innocent into trouble. While you might not be held criminally responsible for something your partner does, any benefit that the company received, you received also. This is the logic used in lawsuits and in trials.
Less serious, but perhaps just as troubling is non-performance. You will be contractually obligated to anything a partner agrees to in the business name. The only real prevention is good communication between partners. Keep it open and honest. A breakdown almost always leads to the death of a partnership.
Partnership Credit and Financing
Loans are easier to get under a partnership agreement simply because there are more people cosigning. Having multiple partners ‘on the hook’ means banks have more resources to attach should things go badly. Other than this, financing is handled in much the same way as with a sole proprietorship. Usually, a business is split up (in the partnership agreement) along the lines of how much each partner brought into the startup. Ownership is often based on these lines but might be modified if one partner brings a necessary skill (that the other lacks) or physical asset.