Everything You Should Know About Setting Up a Partnership
When it comes to starting a business, a partnership is a specific type of entity that includes certain rules and guidelines. Though the interpersonal aspect may be complicated, partnerships are simple and inexpensive to form from a legal perspective, making them a popular choice for people who want to go into business together.
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What is a partnership?
A partnership is any business with more than one owner that has not filed papers with the state to become a corporation or a limited liability company, or LLC. Partnerships operate in the same way as sole proprietors in a sole proprietorship, but instead of one owner, there are multiple. If you have started any joint venture, it can technically be considered a partnership, as no formal paperwork is required to establish one.
Different types of partnerships
There are multiple types of partnerships that can be formed, depending on the role of each owner and how the responsibilities are shared.
General partnership
The most common and simplest form of a partnership is a general partnership. These are simple to start with as they do not require any government paperwork to be filed. Most people will create and sign a partnership agreement to set the terms of the business, but this is not required.
In a general partnership, the ownership and profits are usually split equally among all business partners, or in a different allocation laid out in a partnership agreement. Each partner will have the individual power to bind the business to contracts and loans, and they will each take on total personal liability. All profits, losses, and liabilities will be split according to the way ownership is split.
General partnerships involve a high level of trust, as one person could be responsible for the actions of other partners. They are also automatically dissolved if any one partner were to die or go bankrupt.
Limited partnership
Unlike general partnerships, limited partnerships do involve authorization through the state and are more formal business entities. Each limited partnership will have at least one general partner, who is fully responsible for the business, and at least one limited partner who provides money without actively managing the business. A limited partner is an investor and is entitled to financial returns, but is not responsible for debts and liabilities.
Limited liability partnership (LLP)
Similar to a general partnership, a limited liability partnership has all partners actively involved in and managing the business. However, this form of business will limit the liability they have for one another’s actions. Debts and legal liabilities of the business will still be split, but errors and omissions of one partner cannot be used against the others.
LLPs are not permitted in all states and may only be available to certain high-liability professions, like doctors or accountants.
Limited liability limited partnership
In some states, a limited liability limited partnership can be formed. These operate like limited partnerships, in that there is at least one actively managing partner and one silent partner, but each party is granted additional liability protection. This is a newer form of business that is not well understood in many cases.
Who should form a partnership?
Any time you are looking to start a business with more than one owner, a partnership is a viable option. However, there are alternatives that could be considered, so it is important to be sure this format is right for you.
Because of the shared liability involved in a partnership, it is important that you have a good deal of trust in your fellow partners before going this route. Starting a partnership with strangers or those you have a tenuous relationship is generally not advised. If you do choose to pursue a business with outsiders, like investors, be sure to choose a type of partnership that will protect you both and execute an ironclad partner agreement.
General partnerships are good options for those looking to start a business quickly, without spending much money or going through a lot of red tape.
Advantages of starting a partnership
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Sharing the workload
Starting any business can be overwhelming and stressful, especially if you are doing it alone. Having a partner automatically gives you someone to share the burden of decision-making and all business-related tasks. Being able to divide and conquer, or each take on your area of expertise can be a huge benefit.
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Added knowledge
Most people don’t start a business knowing everything there is to know about their industry. Partnerships can allow you to bring together different knowledge and histories to help your business be more successful. Many partnerships have one person in charge of finances while the other carries out services, or an older more experienced partner can help mentor a younger partner. The success of many businesses can be attributed to shared knowledge and experience.
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Eased financial burden
Even though a general partnership doesn’t have any formal filing fees, starting a business can be an expensive endeavor. Whether you have an investor as a partner or split the costs equally, not being responsible for each line item can be a relief. The liability for debts and other obligations will also be split, which can relieve stress for many business owners.
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Simplified processes
Without needing to formally file to start a partnership, there is already less work to do. Compared to other structures like a corporation, partnerships are much simpler, with a reduced workload on the front end as well as a much less intensive process for annual reports and tax forms when the time comes.
Disadvantages of starting a business partnership
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Profit-sharing
When you are the only one running your business, any hard-earned profit goes right back to you. In a partnership, that profit has to be split in whatever manner your written agreement lays out, and you may not find it fair at the moment. The split will vary by type of partnership and be based on each partner’s investment, but there is bound to be some level of sharing.
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Shared decision making
Partners have to make big business decisions about the future, and sometimes they don’t agree. While a partnership agreement can help alleviate these issues by setting terms, it can be difficult to own a business and work hard, yet not have the final say. If your partner is a family member, friend, or other loved one, it can be difficult to maintain an outside relationship through disagreements.
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Personal liability
In many cases, all partners are legally and financially responsible for the entire business. That means if someone else borrows against the business or makes a mistake that leads to a lawsuit, you can be held liable and lose your own financial and personal assets. Certain forms of partnerships, like an LLP, protect against this.
Steps to setting up a partnership
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Choose your structure
Once you know you are ready to form a partnership, you will still need to decide the type of partnership you will be forming. Start by researching the types of partnerships that your state allows, then discuss with all other partners which one is the best fit. You should consider factors like who will be providing funding, the goals of the business, day-to-day operations, and tax implications. This, and a conversation with any attorneys or tax advisors you work with, can help make the decision on what type of business fits your needs.
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Execute a partnership agreement
It is not required that you have a partnership agreement in place, but it is highly recommended. This document is similar to a corporation’s articles of incorporation and should be the foundation for your business. A good partnership agreement will cover how the business will run, how profits and losses are shared, what daily activities look like, and what happens in circumstances like the departure of a partner.
All partners will need to sign the agreement and it should be kept on file permanently. You can find templates for an agreement online or work with a lawyer to help draft one.
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Name your business
Each state will have a set of rules around including partner names in your business name, with some more lax than others. For example, Massachusetts does not allow a limited partnership to contain the name of the limited partner in the business name- unless it is also the name of a general partner OR there is a history of business being carried out in their name. You will need to read the rules carefully to ensure you follow them.
There may also be other rules about the name of your business, like if they can include suffixes denoting the structure and if they must be spelled out (ie, ending with LP or limited partnership.) You will also need to choose a name that is not taken by any other business. Most states have a registry online that you can use to look this up.
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Register with the state
For a general partnership, there is no registration you need to complete. However, if you are forming an LP, LLP, or LLLP, you will need to register with the state your business will be in. This will usually include filling out a certificate of partnership and appointing a registered agent in order to apply.
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Obtain licenses, permits, and zoning clearances
Even if you do not need to register your general partnership, you may need to apply for certain licenses and permits within your state or locality. If you will be selling or renting anything, you will likely need to obtain a seller’s permit in order to collect and remit state sales tax, and some states require a general business license.
Be sure to look into not only your state’s laws but also the town or county where you will be operating as they may have additional requirements. Certain professions may also require federal, state, and local licensure.
What resources are available to provide further assistance?
Most of what you will need to start a partnership will be specific to your state, with information available through the state department. Below are some resources that you can use to navigate this process.
- The Internal Revenue Service, IRS, provides information on how to form a partnership and handle it when filing personal income taxes.
- The U.S. Small Business Association has information on how to register with federal and state entities.
- This website has a directory of all Secretary of State offices and websites for easy access.
- One example of a template that can be used to create a partnership agreement can be found here.
FAQs
Do partnerships have to have an agreement in place?
No states have a law requiring partnerships to establish a partnership agreement. However, state partnership laws will govern your business if you do not have your own agreement in place. It can also leave you open to disagreements and future risks of not having one.
Who pays taxes in a partnership?
Partners are considered the same legal entity as their business for tax purposes.
The business doesn’t pay income tax, instead, partnership income is “passed through” the business to each partner. They individually report their share of profits and losses on individual federal tax returns, which are reported quarterly. Partners may be eligible for certain pass-through tax deductions as well.
Is a partnership the same as an LLC?
No, each is a separate form of business structure. Partnerships do not require the same formal paperwork as an LLC, which will have stricter processes and requirements. Additionally, an LLC offers protection from personal liability when it comes to business debts and legal obligations. In contrast, a partnership will hold all partners personally liable for any of these debts and liabilities.
How do you name a partnership?
If a partnership agreement lists a business name, that is considered the legal name of the partnership. Otherwise, the legal surnames of the owners will be used as the business’s legal name. When choosing to name your business, each state will require certain formats and regulations related to the name, and you cannot duplicate an existing business name.
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