What Is a Partnership and Is it a Good Idea?

A partnership is two or more people working together in a business or trade. Learn how different kinds of partnerships work and why they might be a good idea here.

You've come up with a marvelous business idea with one or more other people, and now you want to launch the company. 

The default entity for more than one business owner is a partnership. These structures are the most flexible, require the least paperwork, and are not complicated to maintain and operate. Read on to learn more from Hoist about partnerships and whether forming one is the right move for your small business.

Types of Partnerships   

Looking at the forest from the trees, a partnership is formed between two or more people to carry on a business for profit. You can establish a partnership around any business idea, whether it's creating a lemonade stand or a law firm. 

As long as the partners are working together in some fashion to share profits and losses, they have a partnership. Now, let's look at the specific trees and dive deeper into the different types of partnerships.

General Partnership    

When two or more people come together to form a business for profit (even if they never make one), they will have created a general partnership (GP). The law presumes that partners in a GP will share equally in management, control, profits, debts, and losses related to the partnership. 

You can form a general partnership simply by conducting business to make money. You don't need an oral agreement, written partnership agreement, filing, or official registration.

Like sole proprietorships, a GP is taxed and reported on the partners' tax returns. Also, like sole proprietorships, the liability risks with a GP are higher since there is no legal shield to protect partners from personal liability. This type of partnership can be risky to partners in industries with a risk of injury to another, and insurance coverage is not adequate to cover those risks.

Limited Partnership   

Sometimes people come together to form a business but don't want to be equal in every aspect of the company. In that case, a limited partnership (LP) would be a desirable entity choice. In an LP, there are both general and limited partners. 

The general partners have complete control of the business, but they also have unlimited liability. Conversely, the limited partners have no control but have limited liability, including up to the investment cost and not for partnership debts. 

An LP is beneficial for inventors that want to contribute capital and partake in profits but not run the day-to-day business. This kind of structure typically has a partnership agreement detailing the roles of the general and limited partners and outlining how you will handle income, business debts, gains, losses, and dissolution. 

Limited Liability Partnership

By state laws, two or more people that want to form a general partnership can register with the state by filing articles with the state's secretary of state as a limited liability partnership (LLP). Such a registration results in liability protection, which is a shield of sorts, protecting individual partners from personal liability related to the partnership's affairs. 

This type of partnership is a good choice for partners who want to be equal in all aspects of the business and wish to reduce risks associated with the conduct of the business (e.g., operating a fleet of trucks, tree trimming, etc.). 

Limited Liability Limited Partnership  

Let's say an LP sounds attractive to business partners, but the general partner(s) do not want to have unlimited liability. The partners can elect to register with their state and form a limited liability limited partnership (LLLP). 

Here, all the attributes of an LP would be present. However, as with an LLP, a shield would protect the personal assets of all the partners in the event of a lawsuit against the company.

The Advantages of Partnerships 

There are many pros to starting a partnership. First of all, you will have at least one other person to help you carry the burdens of business ownership. This means that you can divide up tasks to work more efficiently, take on more work, and possibly have fewer late nights along the way!

Then there’s the expertise factor. No matter how intelligent and talented you are, you can benefit from another person’s knowledge and skills. For instance, you can bring on a business-minded partner if you have ample experience in the product or service you want to sell but don’t know the first thing about running a company. 

Another advantage of forming a partnership is sharing the financial burden. Depending on the type of business, you might have to pay significant overhead expenses (e.g., office or retail space, equipment, inventory, etc.). 

By splitting the costs with your partner, you can potentially afford more payments upfront, position your company for faster growth, and minimize your debt in the process. 

The Disadvantages of Partnerships  

As with any business deal, partnerships do come with some disadvantages. For example, you must run decisions by your partner rather than act unilaterally. If you want complete control of the company, this could pose problems. Furthermore, if your partner makes reckless decisions, both of you will be held responsible. 

No matter how well you get along with your partner in everyday life, there will be a potential for conflict in the workplace. You will likely have disagreements, and you may even grow tired of working together. Make sure you have a solid exit strategy for this scenario. 

Here’s something else to consider about forming a partnership: Sharing the financial burden means that you must split the profits. Running a company by yourself will allow you to keep all the profits. Splitting two ways can shrink your gains significantly, and if you have several partners, your share can get relatively small. 

What to Consider Before Starting a Business With a Friend or Family Member 

If you are considering a partnership, who will you form it with? You essentially have three options:

  • Friends
  • Family members
  • An unaffiliated third party

We all know stories of successful entrepreneurs who started their first businesses alongside their best friends in a garage. And chances are, many family-owned companies are operating within a 10-mile radius of your home. But it's critical to understand the pros and cons of every option. 

Starting a business with a friend or relative, for instance, likely means that there is already well-established trust. This means that you can move through assembling a team, creating a business model, and other processes more quickly than if you had to find a reputable business partner outside your inner circle. 

Also, you probably share many similarities with your friends and family members, making it easier to agree on a vision for your company. And since you have a long history of coordinating work and life schedules, you may be more equipped to work through scheduling conflicts. 

However, there are advantages to partnering with an outsider. For one, you're more likely to get a fresh perspective from someone you don't know well. Accountability is also more potential because your partner will not be as prone to withdraw criticism. 

Furthermore, when the stresses of running a business begin to mount, you don't have to worry about them impacting your personal lives as much. 

How to Start a Partnership 

So, you have done the homework and decided to form a partnership. Here are the fundamental steps you can expect to take:

Step 1: Choose a Structure

When forming a business with another person, the first step is to choose a legal structure for the company. The typical business entity choices are a corporation, limited liability company (LLC), and partnership. 

As we discussed earlier, when two or more people start a business without intentionally forming an LLC or corporation, a partnership is created by default. Choose one of the four partnership structures that suit your needs and go from there.

Step 2: Draft a Partnership Agreement 

Most small business owners want to jump into business right away and skip the formalities, but it often proves to be a mistake. Take the time to meet with all the partners to discuss the following:

  • Who will have control of the business?
  • How much capital will be invested by the partners?
  • How will profits and losses be split?
  • What happens if a partner wants to leave the company?
  • What happens if a partner dies?
  • Who will you list as the designated partnership representative with the IRS?
  • Who will be responsible for ensuring partners get Schedule K-1s to file with their personal tax returns?
  • What liability protection do partners want?

Once you answer these and other critical questions, it’s time to put the ideas to paper and draft a partnership agreement. Some people try to pull templates from an online search. Still, to ensure you meet all the partnership needs, hiring an attorney is a good idea. 

That way, you'll know it is done correctly and that the interests of all the partners are adequately represented.

Step 3: Name Your Business 

Next, it's time to come up with a business name. This is the fun part! 

Brainstorm to come up with something fun, catchy, and creative. It should convey the mission and values of your business. You have a few options for how to establish a name:

  1. If you choose to be a GP or LP, then you would file an assumed name certificate, meaning you register with the locality of your business and/or state in the name you will be doing business as (DBA) (i.e., Jim Bob and Jane Bob doing business as "Wonderful Business").
  2. If you choose to be an LLP or LLLP, then you can register your partnership with the state and operate under the official name you choose (i.e., Marvelous Business LLP).
  3. You can register your partnership with the state as one thing and file a DBA to operate as something else (i.e., XYZ Partnership LLLP doing business as "Wonderful Business").

Step 4: Register Your Partnership 

To maintain the flexibility of a partnership and limit the partners' personal liability, most business owners elect to register their partnership with the state. In that case, you would be selecting the LLP or LLLP option. 

The state has required paperwork, filing fees, and proper filing procedures to follow. Many people can register their businesses themselves, but you can hire an attorney or use a formation service to ensure it is done correctly.

Step 5: Submit Annual Reports 

LLPs and LLLPs are required to submit annual reports to the state to reaffirm the entity's status, confirm registration details (e.g., addresses, phone numbers, registered agents, etc.), and pay the required state fees. Make one partner responsible for this task to ensure annual reports are submitted timely (avoiding late fees and possible dissolution). 

Many partnerships choose to file the annual report simultaneously as Schedule K-1s are given to partners to prevent missing the deadline.

Ending a Partnership 

The default rule for a partnership is that it may end at any time, for any reason. Of course, that is without a written agreement to the contrary and in the best situation where all partners agree that it should dissolve. Typically, there are three methods by which dissolution can occur:

  • There is a consensual agreement to dissolve the partnership.
  • An event occurs by which the law naturally will dissolve the partnership.
  • A court dissolves the partnership.

In a perfect world, partners who no longer wish to be in business together would agree to wind the company down, fulfill remaining obligations, pay off all outstanding debts, split the profits and losses, and part ways. 

If the partnership is registered with the state, they would then take the extra step to file articles of dissolution with their state. Sometimes, such peaceful dissolution does occur; the partners consensually agree to dissolve and complete the dissolution.

In some instances, the partnership is forced into dissolution. A typical example is when there are only two partners, one dies, and there is no written agreement whereby the partnership interest passes to another person, trust, or company. Since the partnership cannot continue with only one owner, it dissolves. 

In this case, the remaining partner can buy out the partner and keep running the business in a new entity (i.e., limited liability company or sole proprietorship), get a new partner, and have that partner buy out the deceased partner's interest. Or the remaining partner can choose to wind down the current business and cease operating or open up a new business. 

Finally, if partners disagree or one partner has misbehavior that materially affects the partnership's business, one or more partners can always turn to the courts for recourse. Upon proving the partnership should not continue, a court can order its dissolution.

In any case, a successful dissolution will cause the partnership to pay off debts, close all business obligations, accounts and liabilities, and if registered with the state, complete and file articles of dissolution with the state's secretary of state. 

Conclusion

If you’re ready to bring structure to your business idea, forming a partnership is a flexible and low-maintenance way to do it. Consider the pros and cons to confirm that a partnership is the best way forward for your company, and determine who you will start your business with. Then, you’ll be ready to tackle the legal process of establishing your partnership.

Visit Hoist for more on forming a business partnership.

Sources:

Partnerships | Internal Revenue Service

The Process of Choosing a Business Partner | The Balance

How to Write a Business Partnership Agreement | U.S. Chamber of Commerce

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