The Basics Of Partnerships
Read the advantages, disadvantages, tax implications and the legal landscape of using a Partnership structure as an alternative.
Wikipedia defines a “partnership” as
“A partnership is an arrangement in which parties agree to cooperate to advance their mutual interests.”
Partnerships present the involved parties with special challenges that must be navigated into an agreement. Overarching goals, levels of give-and-take, areas of responsibility, lines of authority and succession, how success is evaluated and distributed, and often a variety of other factors must all be negotiated. Once an agreement is reached, the partnership is typically enforceable by civil law, especially if well documented. Partners who wish to make their agreement affirmatively explicit and enforceable typically draw up ‘Articles of Partnership’. It is common for information about formally partnered entities to be made public, such as through a press release, a newspaper ad, or public records laws.
Statutory regulation of partnerships in Canada falls under Provincial jurisdiction. A partnership is not a separate legal entity and partnership income is taxed at the rate of the partner receiving the income. It can be deemed to exist regardless of the intention of the partners. Common elements considered by courts in determining the existence of a partnership are that two or more legal persons:
- Are carrying on a business
- In common
- With a view to profit.
In The United States
The federal government of the United States does not have specific statutory law governing the establishment of partnerships. Instead, each of the fifty states as well as the District of Columbia has its own statutes and common law that govern partnerships. These states largely follow general common law principles of partnerships whether a general partnership, a limited partnership or a limited liability partnership.
Forming A Partnership
Establishing and navigating relationships with other people can be tricky, especially in a business environment. Whether you’re considering a general partnership or incorporating a business with a partner, you’ll need to carefully consider whether that partnership-based structure is the right fit for your business.
Starting a business with a partner offers many benefits, not the least of which is having someone to share the many responsibilities of running a business. But partnerships can quickly go bad if you don’t give it ample forethought and planning. Consider these tips to be sure your partnership lasts.
Finding the Right Partner
Business organizations can be structured in various ways, both in terms of their structures as legal entities and also in terms of the internal structure and management processes. The partnership is one type of business structure. A partnership is the next simplest business structure after the sole proprietorship but it introduces the inherent complexities of multiple parties rather than an autonomous structure as in a sole proprietorship.
Deciding whether to pursue a business partnership is only the first step. Next, you need to make sure you find the right partner(s).
Above all else, the partnership has to be the right fit for all parties, in order for it to be successful. Do a personal inventory of your own skills, then identify gaps that a potential partner could fill.
When searching for a business partner you should look for someone who will bring a complementary set of intellectual assets to the business. Choosing a business partner with the exact same background, education, skills, expertise and experience is just “too much you.”
Make Sure You Are On The Same Page
Once you’ve established that your partnership will be a good fit, (for example, the potential partner is great at sales & marketing, while you’re great with financial forecasting, operations and business strategy), you will have to ensure that you have the same vision, values, goals and objectives for the company.
Come up with these things together and include them in your business plan and strategy. The more aligned you are at the start, the more successful the business partnership. Creating a record of your discussions and points of agreement early can provide a reference point if disagreements crop up or there are misunderstandings later. It can also provide the foundation for discussions about changes in strategy or how you plan to evolve your business plan in future.
Get It In Writing
There is no better time to write a partnership agreement than when you and your soon to be partner are getting along well. If the idea of discussing separation of assets, exit strategies and what to do in the event of a falling out is too stressful or upsetting for you in these heady first days of your business partnership, then frankly, you’re not ready to be business partners.
Involve a lawyer and an accountant from the outset to help form your partnership and to draw up legal agreements. And don’t forget, take your time. Just like a good marriage, you’ll want this business partnership to last.
Since a partnership is typically much easier to get into than to get out of, you’ll want to achieve absolute clarity at its onset. Avoid any potential problems by making sure duties and responsibilities of each partner are detailed in this legal agreement.
A good partnership agreement will include and set forth:
- division of labor including who’ll be responsible for making purchase decisions
- draw up an agreement that outlines your roles and responsibilities in the company
- how much capital each will contribute
- who owns what
- how decisions will be made
- how profits will be shared
- how disputes will be resolved
- a buy-sell agreement
- and who will be entitled to what if the partnership doesn’t work out
- who is bringing what into the company in the form of cash, equity, tangible assets, intellectual property etc.?
- what happens if one of the partners decides to leave the company or dies?
- what happens if your partner is sick or can’t for whatever reason continue in the business?
What about those cases where things go horribly wrong between partners? No one enters a business partnership planning to dissolve that relationship and it’s easy to push legal questions aside when you’re in the exciting days of establishing a business, but don’t let this fall off your radar. Like even the best of marriages, you may not always find yourself heading in the same direction as your business partner, even if you started off in exactly the same place. Exit strategies should be part of your partnership agreement from the beginning.
A large advantage of the partnership structure is its ease in filing taxes and tax treatment. With a general partnership, two or more people can start a business as co-owners with no special formalities, directly controlling the partnership and making binding decisions with a simple majority vote. The partners are taxed individually on their share of the partnership’s profits. By default, profits are shared equally among the partners. However, a partnership agreement will almost invariably expressly provide for the manner in which profits and losses are to be shared.
Owners can be personally liable for business losses in some forms of partnership, meaning their personal assets are not protected against the claims of creditors. The partnership is not a separate entity from the owners/entrepreneurs, unlike a corporation. If the partnership breaks down partnerships are considered to be an aggregate of their partners rather than a separate entity.
Advantages Of A Partnership
- Problem solving: Two (or three or four) heads are better than one.
- Start-up capital: Shared investment allows for more growth opportunity should your business become profitable, while sharing the risk alleviates the financial pressure during the start-up phase and during moments of hardship.
- Complimentary skills: Between the partners you have a broad range of business skills and expertise
- Increased Networking base: Each partner brings their own network of contacts to benefit the firm.
- Teaming up with a partner (or multiple partners) to start or expand your business can make taking that leap a little less daunting.
- Share the workload : You don’t have to wear all the hats in the business. You can even take a vacation and leave your partner minding the business. You have backup. You don’t have to be in two places at one time. You’ll both have better work/life balance.
- Strength in numbers: In the Business to Business (B2B) market you will be taken more seriously if you are a team of two or three versus a sole proprietor. Clients will perceive that your business has more resources behind it, because it does.
- Access to financing: With more people to back a business loan, you may find that you can more easily access financing for your business.
- Support and connection: You have someone else to share the success with.
Disadvantages Of A Partnership
From a legal and personal perspective, the disadvantages of a partnership can have long-term financial repercussions:
- Owners can be personally liable for business losses: This is the primary disadvantage of the structure. The partnership is not a separate entity from the owners/entrepreneurs, unlike a Corporation. If your partner is careless in how he/she manages the business’s finances, then you can be held financially accountable for your partner’s negligence.
- Decision making: If it is an equal share partnership, always coming to a consensus is difficult and time consuming. There has to be one partner who can be the “tie breaker” or who gets the ultimate say.
- Accountability: You do have to answer to your partner(s) – you are not simply your own boss.
- Control: You won’t have total control of every aspect of your business. You will have to be able to trust your partner on every level to make good business decisions and live with them, even if sometimes you don’t agree with their way of doing things.
- Sharing: Sure you share the risk and work, but, you have to share the wealth
- Termination of Personal Relationship – Mixing business with close friends or family members may seem like the ideal option when putting your trust in a partner. However, when financial stresses and personal differences come into play, you are putting your personal relationship in jeopardy. Remember John D. Rockefeller’s famous words: “A friendship founded on business is a good deal better than a business founded on friendship.”