Shouldering the sole responsibility of running a company is a daunting task. A business partner can relieve some day-to-day burdens while improving your firm’s financial health. However, small business partnerships can fail when conflicts cause chaos, erode trust, and halt communication.
Follow these guidelines and legal requirements to create a business partnership that lasts and avoids complications.
Explore the advantages and disadvantages of business partnerships
Could a partnership help you manage or grow your company? Or will sharing decisions and liabilities lead to disputes? Answering these questions can help you understand the risks of forming a partnership and your goals for going through with it. Develop insights to set up your collaboration effectively by understanding the pros and cons of small business partnerships.
Why consider a business partnership?
If you have unique talents or industry knowledge but don’t know anything about sales or marketing, a small business partnership could help your company succeed.
The advantages of a partnership include:
- Partners can share costs and liabilities to reduce personal risks on both sides.
- Different viewpoints can help owners assess strategies and find gaps.
- Collaborators may bring assets and resources to establish or grow a business faster.
What are the risks of forming a partnership?
Entering a small business partnership means giving up some control and profits. Conflict resolution must be swift when issues arise because your company is on the line.
Depending on your partnership contract terms and business structure, disadvantages could include the following:
- Partners could be liable for debt even if an associate signs for a loan without the other’s consent.
- The contract defines how profits are shared, which may not reflect the effort partners put into operations.
- Conflicts, illness, or death can prevent business from proceeding as usual.
Choose the right partner
Relinquishing control is a hard thing to do, especially when it comes to your company. Once you give up equity, it’s hard to get it back, so choosing the right business partner is crucial.
Like all relationships, the ability to compromise is vital, but sharing the same fundamental values with your business partner will lessen the strain of those compromises. It takes time to cultivate partnerships and fall into a fine-tuned dance, but picking someone based on optimal compatibility can get you in rhythm sooner.
When creating a business partnership, look for associates with top qualities, such as:
- Trustworthiness: Do you have confidence in this person?
- Attributes: What expertise and traits do they bring to the table?
- Financial viability: Are they fiscally sound and able to contribute?
- Strengths and weaknesses: Can their skills counter your shortcomings?
Legal considerations for business partnerships
Legal requirements for forming a business partnership differ by state, and decisions during the setup process affect liabilities, taxes, and operations. Notably, general partnership law is fairly flexible and lets partners “establish their own rules for how the partnership operates,” according to Nolo. This means that partners can agree to terms different from state law. Here’s what you need to know when establishing small business partnerships.
Selecting a partnership structure
The business structure you choose for your partnership determines the amount of liability each party takes on and the tax benefits you'll receive. The advantages and disadvantages vary among entities, so check with an advisor to explore options to legally structure a small business partnership.
Once you give up equity, it’s hard to get it back, so choosing the right business partner is crucial.
Consider the following types of business partnership structures:
- General partnerships divide profits, liability, and management duties equally. They are easy to start, low-cost, and flexible, but you take on liability, putting personal assets at risk.
- Limited partnerships allow one partner to have all the control and carry all liability and the other partner to have limited (if any) liability and control. Passive investors may prefer this type of business partnership.
- Limited liability partnerships (LLPs) protects partners' personal assets and limits individual responsibility for the company's debts or other associates' actions. This can be the best entity structure for a small business partnership between lawyers or accountants.
- Limited liability companies (LLCs) let you legally structure a small business partnership to shield all members from liability or bring on foreign entities as associates. The IRS allows companies to elect corporate or pass-through taxation.
Preparing a detailed partnership agreement
Entering into a business partnership is a complex process. A comprehensive contract between you and your associate provides a solid foundation for a successful collaboration. Even if you partner with a friend, executing a formal agreement offers both parties legal protection, dissolves ongoing disputes, and helps guide you when making crucial business decisions.
A good business partnership agreement outlines each person's contributions, expectations, and duties, dictates financial allocations, and instructs how you make decisions, from terminating staff to taking on debt. The terms also settle disagreements that can turn volatile and end the relationship.
On a Business Law Podcast, Ellen Waldman, Vice President at the CPR Institute (International Institute for Conflict Prevention & Resolution), suggested that business partners include a “formal statement of intent” in formal relational contracts. It should reflect “a jointly developed shared vision, guiding principles, and a modeled set of behaviors that both parties agree will be part of the relationship.”
In short, the more detailed the partnership agreement is, the better. Working with a lawyer when writing a partnership contract can protect your interests and help ensure business continuity through challenging times.
Understanding regulatory and tax requirements
As a member of a partnership, it’s your responsibility to comply with government regulations and manage taxes. Laws and taxes may vary depending on the location and type of business conducted and how you structure your partnership agreement.
Multi-owner structures are often pass-through entities for tax purposes. The company reports its gains and losses using informational IRS Form 1065, then files and distributes Schedule K-1 to each partner. You will report any income, losses, deductions, and credits on your personal tax return using Schedule K-1.
However, LLCs can elect S-corp taxation to take advantage of the additional tax benefits of business partnerships. The business structure and contract determine how the company distributes profits and losses and what tax forms and annual reports you must provide to partners and tax authorities.
Most business partnerships must register with federal, state, and local agencies and obtain a tax and employer ID number. In addition, you may need other types of licenses and permits, including a business license, DBA license, sales tax permit, or industry-specific license. Check with your state and locality to confirm permit and licensing requirements.
How to handle disagreements and conflicts in a partnership
Even the best business partnerships dissolve when people can’t agree. Opinions over financials, responsibilities, and strategies can result in distrust or resentment, ultimately leading to breakdowns in communication.
Follow these tips for managing disagreements in a business partnership:
- Establish structured communication processes for meetings, issues, and documentation. For example, you could track concerns in a spreadsheet and use AI tools to summarize and save meeting transcripts.
- Include clauses for handling partnership disputes in your contract, such as mediation as the first step for conflict resolution, followed by arbitration. These may prevent escalation and cost less than litigation.
- Appoint a neutral third party, like a mentor, trusted advisor, or business consultant, who can step in and listen to both sides.
- Ensure transparency by defining how you’ll make decisions and using technology to streamline communication. For example, set thresholds for when decisions require joint approval and use project management software to track tasks, automate reports, and record decisions.
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