Starting a partnership can be an easy process, but make sure you don’t skip any of the steps just because they are easy.
What is a Partnership?
My best definition is an unincorporated business owned and run by two or more people. Like a sole proprietorship is the default if one owner, the partnership is the default business structure if a business has two or more owners for legal liability and tax purposes.
Each partner will be given a share of the business ownership that reflects their percentage of share in profits (or losses) and their ability to make decisions about the business.
Like with a sole proprietor, the partners and the business are not separated, and they each pay taxes on their portion of the businesses profit or loss on their personal 1099’s. This is know as pass-through entity.
Having more than one owner will make it a more complicated business structure, but my hopes are to show you seven easy steps to start a partnership the make the process quicker and easier for setting up and running properly.
Advice Before Starting a Partnership
The best partnerships come from people who are complementary to each other as there are several responsibilities that need to be filled in the business. Even if you have known each other since the crib, make sure that you are well suited to work together.
Partnerships can be a bit like a marriage so doing an evaluation of each partner’s strengths and weaknesses is a good idea. Also make sure that each of you is not bringing any “baggage” into the mix like credit problems, past history, etc. that could hurt the business down the line with applying for credit like loans or credit cards.
First Easy Step: Partnership Type Decision
The first decision when starting a partnership needs to be what type of partnership do you all want to start. There are three types of partnerships to choose from:
- General Partnership– This is a partnership in which all partners are general partners, meaning that they all participate in the day-to-day decisions and all the owners have the same share powers. The share distribution is usually equal but doesn’t have to be.
- Limited Partnership. This is a partnership where there is at least one general partner and at least one limited partner. General partners have the ability to make day-to-day decisions, limited partners do not.
- Limited Liability Partnership. Each partner is shielded from liability of the business up to the percentage of their ownership.
It is important to remember that general partners are limited to the amount of profit or loss they collect by their percentage of ownership, but liability is not limited. Each general partner can be held 100% liable for the financial debts or legal judgments of the business.
Limited partners are limited in their liability but are also limited in their powers as a partner.
Second Easy Step: Partner Decisions
There are several decisions that will have to be made about partner required contributions, partner types, and partner shares that need to be spell out before starting the business. Take into consideration your decisions in Step One as you make these decisions.
Partner Required Contributions
When starting a partnership, each partner is required to make “contributions” to the partnership to purchase their share of the business. This contribution is often money, but the work they will do for the business or assets/equipment can be given a dollar equivalent to purchase the shares.
If the business is willing to take a partner on after the initial formation, there will have to be a contribution amount decided as a portion or one or more partners will have to be “sold” to the new partner since the partnership shares must equal 100% between the partners at all times.
Partner Types
What type of partners do you want when starting a partnership? General, Limited, Limited Liability? How will the percentages be distributed? Equal, unequal? How will the responsibilities of the partners be divided? Day-to-day activities, other decision-making responsibilities?
General partners have day-to-day responsibilities, share in profits and losses to their percentage share and bear possibly full liability for the partnership.
Limited Partners have no day-to-day authority, share in profit and loss to their percentage share but bear only the amount of liability for the partnership up to their percentage share.
Limited Liability Partners (all partners must be a limited liability in this model) can have the day-to-day responsibilities or not, share in the profit/loss and liability in the amount of their partnership share percentage. Some states allow attorneys, doctors, or accountants to set up Professional Limited Liability Partnership.
Partner Shares
Shares can be equally divided or can be based on type of partner, contribution, seniority, or any other factor deems worthy. These shares must add up to 100% and each partners percentage is called a distributive share.
Each partner will be given a form that shows the business’s profits and losses and that partner’s distributive share of those profits and losses to be filed with their personal federal taxes.
Third Easy Step: Naming the Partnership
When starting a partnership, come up with a list of names that the partners can agree on and then rank them. Take into consideration what kind of business the partnership will be doing (Best Little Deli), names of partners (Dewey, Cheatem, and Howe), memorable names (Lightning Deliveries), location (Washington News), or anything else that distinguishes the partnership.
Once you have your list of ranked names, go to the business division of the state you will register in (or all states you will register in) and do a name search to see availability.
Keep in mind that most states require you to put LLP or PLLP at the end of the name if you decide on a Limited Liability Partnership/ Professional Limited Liability Partnership.
Fourth Easy Step: Drawing Up a Partnership Agreement
A partnership agreement sets out in writing all these decisions discussed above, plus things like dissolution of partnership, how the death or withdrawal of a partner will be handled, how future partners may be added, what issues require majority vote and which require supermajority, how a partner can be asked (forced) to leave, and much more.
It is much better to iron out issues before starting a partnership than waiting until the partnership is already established and then the issues arise.
Fifth Easy Step: Register Your Partnership
There is rarely any reason to register a business anywhere other than the “home” state of your business. This is the state where the business has its home office if operating in more than one state.
Once you have agreed in the partnership agreement the partnership name, type of partnership, percentage of shares, and responsibilities; the business needs to be registered with the business division of the state (usually Secretary of State Office). While like a sole proprietor, this is often not a requirement of the state, it is best to do so when starting a partnership (or register DBA) to reserve the name to protect it from being used by anyone else and makes you look more professional when applying for lines of credit.
If you do plan to operate in more than one state, the main and first state is called a domestic partnership and the subsequent state registrations are called foreign partnerships.
I will do an article soon about what to include in a partnership agreement so you don’t miss anything.
Sixth Easy Step: Get an Employer Identification Number (EIN)
Even if you do not plan to have employees, it is best to register with the IRS for an EIN immediately when starting a partnership. It is an easy (and free) process to apply and the EIN will not only make you look more professional, but it may also be required to get business bank accounts, credit cards, or bank loans.
There are four ways to apply for it, but if you apply online or by phone, you get the number immediately.
Beware of fake Employer ID application websites and their scams. These sites will look like you are filling out the application, but when you input all your info into them, they then ask for money to file it for you. The application is free through the IRS website to apply and you will be given a number immediately.
Easy Step Seven: Get other Registrations, Licenses, and Permits
Depending on your location, type of business, and city/county regulations there may be other registrations, licenses, or permits needed. Here is a quick list, but likely not exhaustive, to get you started:
- If you sell a taxable product or service, you will have to register with your state to collect and send them sales taxes. A recent Supreme Court decision allowed the state to even require this for internet sales.
- Many cities require you to file for a permit to operate certain businesses within their limits
- Depending on the type of work you do, some professions require all partners to have a license giving by the state to practice their profession.
Consider Using an Attorney
Just as a last piece of advice, the cost of hiring an attorney will likely be worth it, in the long run, to help you set up your partnership. While the state registration and EIN number are fairly easy to do and have people able to help you, it is wise to hire a business attorney to help you draft the partnership agreement.
An attorney is going to know state specific requirements, issues that have arisen in other partnerships, and bring up questions that need to be decided that the partners may not have thought of.
To help possible save on cost, try to come up with an agreement prior to seeing the attorney and let them add or subtract to the agreement for the reasons in the last paragraph
Good luck with your partnership endeavors!