Guide to Starting a Business Partnership
Depending on the type of business partnership you want to form — and which state you live in — the process can be nuanced and potentially complicated.
Before you even create your business, there is also a series of questions you should ask both yourself and your potential partner. After all, choosing the right partner could make or break your business.
Follow this guide to ensure you start your business partnership off on the right foot.
Whether you’re a hairstylist joining forces with a close friend to open a salon, a chef opening a restaurant with an angel investor or a stay-at-home mom who wants to sell handmade jewelry on the side with your sister, business partnerships can take myriad forms.
A business partnership simply means you are part of a business structure that involves two or more people, according to the U.S. Small Business Administration (SBA). There are three primary types of business partnerships — general, limited and limited liability — which are detailed in the following section. They vary in their structure, filing requirements and liability protection.
There are three primary forms of business partnerships: a general partnership (GP), a limited partnership (LP) and a limited liability partnership (LLP).
Worth noting, says Ford W. Harmon, an attorney at Maddrey PLLC law firm in Dallas, is that partnerships vary slightly based on the state you’re performing your business in. “They mostly have the same characteristics, but there are a few different variants,” Harmon said.
Check the filing requirements for your state to learn about the subtle differences that might exist. (You can usually find those requirements on a state website.)
Below are the three primary forms of business partnerships, with explanations for which is ideal in certain scenarios:
A general partnership is essentially the default option for business partnerships, Harmon says. Put simply, if you’re working with someone else in business to gain a profit, you are part of a general partnership.
“You don’t have to do anything or need to file anything,” Harmon said.
Because a general partnership doesn’t require an official filing with the secretary of state or equivalent government agency, “it’s something that can happen and even exist without parties knowing they’re in a general partnership,” Harmon said. In fact, intent to form a general partnership is typically not required in order to be part of one, depending on the state you live in.
The major downside of general partnerships is that they offer no personal liability protection, Harmon says. For example, if you and your business partner own a dog-walking business and a client’s dog runs away, the client could sue the partnership as an entity — you and your partner — even if you weren’t the one walking the dog at the time. Your personal assets can also be recovered to cover damages awarded in a court case. “It’s usually something you want to avoid being part of, because there’s no liability protection,” Harmon said.
When a general partnership makes sense:
Because of their lack of liability protection, general partnerships typically don’t make sense from a legal standpoint. They could be sufficient for situations in which your business is super small, or if you want to run a business with simpler tax filing and less paperwork.
When a general partnership doesn’t make sense:
Andy Gaunce, a business attorney in St. Petersburg, Fla ., says general partnerships don’t make sense for business partnerships in which the partners have significantly different levels of day-to-day involvement.
“What is a general partnership not good for? It’s not good for situations where you have what I would call an investor — who’s going to be passive — and a person who’s going to be active in the business,” Gaunce said
It also doesn’t make sense for businesses with potentially high liability. “If I have a client come in who’s acting in a general partnership, that’s something I very much try to discourage them from continuing because of how dangerous it is for their personal liability,” Harmon said.
If you’re looking to form a business partnership with more liability protection, you might want to consider forming a limited partnership. Limited partnerships, according to Harmon, have one or more general partners and one or more limited partners. They are formed through the state.
“The general partner is exactly as if they were in a general partnership — if it’s an individual, they are liable personally for the obligation of the partnership,” Harmon said. “And the limited partner or partners would be shielded from personal liability.” The general partner in this partnership must pay self-employment taxes,
Gaunce cites restaurants as a prime example of limited partnerships. High-end restaurants often feature a more active partner (the chef) and a less-involved investor who wants to contribute financially to the restaurant. A limited partnership would be ideal in this situation because in the event the restaurant was sued, the investor’s personal assets would be shielded from the lawsuit. In short, the limited partner in a limited partnership avoids the day-to-day operational risk of business, Guance says.
“A limited partnership is ideal for when you have a passive investor and an operating partner,” he said. “That’s because the passive investor can put a bubble around themselves and get limited liability.”
When a limited partnership makes sense:
Limited partnerships are ideal for businesses in which one partner is more active, while the other serves as more of a financial backer, such as the restaurant example cited above. Gaunce says limited partnerships are often seen in commercial real estate when a developer builds a property (the general partner) and investors provide the financial backing (limited partners).
When a limited partnership doesn’t make sense:
One qualification for being a limited partner in a limited partnership is that the limited partner cannot participate in the day-to-day operations of the business, Gaunce says. A limited partnership doesn’t make sense for a business in which two or more partners all want to be equally involved in the daily operations.
Limited liability partnership
Another form of a business partnership is a limited liability partnership, which gives limited liability to every partner. Harmon says that limited liability partnerships have more variance at the state level.
In certain states — such as Texas, where Harmon practices law — you can file to have a general or limited partnership converted into a limited liability partnership. “Filing to convert it to an LLP pretty much transfers a general partner’s liability to that of a limited partner so that everyone is protected in terms of their personal assets,” Harmon said.
Gaunce, who has been practicing law for 11 years, says he has never helped form a limited liability partnership. “It’s never really caught on the way LPs have caught on and the way ,” he said. Much of this has to do with history and familiarity, Gaunce says. Limited liability partnerships didn’t come about until the 1990s, and state laws regarding limited liability partnerships vary significantly.
Limited liability partnerships can sometimes be limited to professional organizations depending on the state, Gaunce adds. “LLPs tend to be most used by professionals due to state-law restrictions on what types of entities they can use when practicing their profession,” Gaunce said.
When a limited liability partnership makes sense:
Limited liability partnerships make sense in situations in which all business partners have personal assets they need protected.
When a limited liability partnership doesn’t make sense:
Limited liability partnerships don’t make sense for situations in which the business partners will have different levels of day-to-day involvement in the company.
If after reading these descriptions you think a partnership may not be the best business structure for you, there are many others you can choose from. Gaunce says a limited liability company (LLC) may be the next logical thing to look into.
“I typically advise entrepreneurs to form an LLC due to the flexibility and the reduced amount of formalities when compared to corporations,” Gaunce says. “There are also potential tax benefits for LLCs versus corporations.”
Harmon provides further insight: “Partnerships — GPs and especially LPs — were much more popular entity vehicles before the LLC came into existence. The LLC is almost a hybrid of an LP and a corporation, taking the best parts of each, so there has been a massive shift in entity vehicle choice toward the LLC.”
Before you officially form a business partnership, you should have a deep and thorough understanding of the factors that contribute to a successful partnership.
Matthew DeYoung, an executive leadership coach based in the Chicago area , says two things contribute to a successful partnership:
- Written plans and goals.
- Company culture and climate.
DeYoung says the second, less tangible factor matters just as much as the first. “We get the plan, we get everything in writing — the spreadsheet, the org chart, the roles and responsibilities,” DeYoung said. “We get all of that done, and here’s the issue: It’s all kind of theoretical until we start working together.”
DeYoung says he advises clients to address their definition of success from the outset. Talk with your potential business partner about what success means to you, both on a long-term and daily basis.
“Asking the definition of success is the most important thing to lay a good foundation for a strong partnership,” DeYoung said. “And all I mean there is: Are you going in the same direction?”
DeYoung says to ask both yourself and your potential partner why you’re starting this business, and what would have to be true in order for this partnership to be successful. “We preserve ourselves for the right partnership by having a clear and upfront definition of success and what direction you’re going in,” he said.
He adds that there are three things you should be concerned about in a potential partner: unclear priorities (both long-term and day-to-day); limiting beliefs about the future potential of the business; and a lack of trust. If your potential partner demonstrates any of these qualities, consider it a red flag.
Selecting the optimal business partner is just as important as the business concept itself. A business partnership is like a marriage, and you should do your due diligence from the outset to ensure your business partnership will be as successful as possible.
Jason Rosado, a business and executive coach in Chicago , advises clients looking to start a business to first create their ideal job description and write down what areas they’d like to be involved with in their business.
“Then, if they’re considering a partnership, they should be looking for somebody who complements areas they don’t already have covered within that job description they wrote for themselves,” Rosado said.
In addition to finding someone who complements your skill set and strengths, Rosado says it’s important to find someone who has the same values, long-term goals and vision for the business as you. “You want to be able to challenge each other, push each other, critique each other and be able to take those critiques well and deliver them well,” Rosado sid.
Bringing in a business partner who can provide capital is common practice. But Rosado says he warns clients of doing this if the reason they’re bringing this partner in is solely because of the capital that person can offer.
“You can get funding from somewhere else, you can hire marketing people, you can hire salespeople,” he said. “You really just want to make sure that you are in sync with this person and you’re excited to work with them.”
When considering a potential business partner, ask yourself these questions:
- What can this potential partner bring to the company? Don’t just rely on your gut feeling that a friend, family member or former colleague will be a good partner. Before you even decide to form a business partnership, take a good, hard look at what this person can tangibly bring to the table. “Waiting to see who will do what is a total waste of time and it’s an endless loop,” DeYoung said.
- Which partner will be in charge of the business? DeYoung says one problem he sees new business owners face is a power struggle regarding who’s in charge. “A lot of times, what happens in a partnership is there’s so much time spent storming and forming, there’s conflict as they try to figure out who’s really in charge,” he said. If one partner is going to helm the business, figure this out from the get-go.
- Do you and your potential business partner share the same personal values? “You have to make sure that you’re on the same page in terms of having the same values,” Rosado said. A lack of shared values could lead to significant problems down the road. Talk with your potential business partner about the goals and vision you have for the type of business you will run.
- What role will you and your prospective business partner hold in the business? “You want to have clearly defined roles of who is in charge of what in the partnership,” Rosado said, adding that he has seen countless partnerships in which the workload was very lopsided. Make sure you’re choosing someone not only who will work hard, but who has a skill set that complements yours.
You’ve done your due diligence on which type of business partnership you’d like to form, and who you’d like as your partner or partners. Now what?
The process for forming a business partnership varies depending on the state you live in, but there is a set of general steps you can take to form your partnership:
1. Establish each partner’s duties and responsibilities.
Talk with your potential partner about who will be in charge of which areas of the business. Make sure you have everything covered, and that each partner feels comfortable with each area they’ve decided to helm.
In addition to outlining each partner’s roles and responsibilities, you should discuss control (who makes decisions and how), cash flow (how you will split up shares) and what will happen due to any potential unforeseen circumstances, such as death, bankruptcy, disability or divorce.
2. Create and sign a written partnership agreement.
This step is crucial. You cannot simply rely on what a potential partner says he or she will do. Gaunce says signing an agreement is important in the event that one partner does not complete his or her duties.
“A lot of people think that if their partner stops doing their job, they’re not entitled to any of the money,” Gaunce said. “That is 100 percent incorrect, and the largest source of strife that I see between partners.”
Guance says that unless there is a mechanism built into the partnership that allows one partner to get rid of the other, the rule in most states is that even if a partner isn’t putting in his or her share of work, he or she is still entitled to 50 percent of the profits.
“The way to avoid that is to come up with some type of partnership agreement,” Gaunce said. “Without that partnership agreement in place, if you decide three months later that it’s not going to work out and you guys are going to go your separate ways, it becomes exponentially more difficult and costly to make that happen.”
3. Form your partnership.
Once you’ve identified your business partner or partners, your business’s name and which state your business will function in, you can visit the appropriate local agency — depending on your state — to get started. You will also want to obtain an Employer Identification Number (EIN) if you don’t already have one. You can apply for one online through IRS.gov.
Gaunce says he always advises people interested in forming a business to seek legal advice, even if the cost seems prohibitive.
“A big deterrent people face [when seeking legal advice] when trying to form a company is cost,” he said. “I would encourage people to shop around for different lawyers. You should always ensure the attorney you work with has sufficient knowledge and experience working with business owners, but you might be surprised at the variation in cost you find even among experienced lawyers.” Gaunce adds that it’s always wise to add a line item to every business plan for professional fees, such as accountants and lawyers.