Everything You Need to Know About Business Partnerships (Especially With a Friend or Relative)

As if entrepreneurship wasn’t scary enough, we have this incomparably unknown and yet timeless institution of corporate America, from the smallest endeavor of the lemonade stand to a superior launch of a law firm — the business partnership. Of course, one would think that such a thing would be a lot easier to deal with than simply being a sole proprietorship as many entrepreneurs are. That’s not the case.

business partnership

You’re cooperating with another human being, basically. It’s a type of unincorporated business, subject to everything like taxes, certain regulations and even government inspections depending on the industry you’re in. There will always be conflicts of interest, disagreements and legal repercussions. You’re not just a 1-man band anymore. You’re right off the precipice of being a full-fledged company, just without the headline, board of directors and workforce under you. Treading that line can be a bit scary.

As long as you are aware, though, of what’s going on with your business and what to expect of the partnership, it’d be smooth sailing for the most part. You definitely need to make sure you register with the IRS, creating something legally binding. That being said, here are some things you’ll need to know about business partnerships, specifically when it’s with a friend (or even a family member!).

First Off, What Are the Benefits?

Are there benefits to forming a business partnership? You have options; that’s for sure. You could file for an ‘incorporation.’ But a business partnership, basically the next step up from a sole proprietorship, has the benefit of less paperwork and fees to worry about.

Typically a corporation or incorporation comes with a more structured formula whereas a business partnership is more flexible, very much like an LLC. Each partner ends up contributing to the decision making of the business on a more equitable field of play, through profit sharing, which also helps shoulder the tax responsibility. In other words — the job of running the business is a lot easier when you have someone running it with you.

Additionally, the work dynamic thrives as for the most part the partners work together a lot better than even senior management level executives of a large corporation can, plus the power of inclusion can be a tempting incentive for motivation of certain star employees who are then regarded as ‘partners’ in the business.

You Do Need to Know What Type of Business Partnership You’re Getting Into, Though

There are three to keep in mind. Legally, it would do you well to consult with your attorney about which one might fit your needs.

  • General Partnership — This is the simplest of the three, basically dividing all profits, liability and management right down the middle or in any permutation you like. There’s no confusion, no hassle and no trouble.
  • Limited Partnership — Perhaps you might want to be the wizard behind the curtain, calling the shots but not necessarily taking any ‘credit’ for it? This agreement can best suit you, as it often focuses on the silent partner of the group, the individual responsible for the ‘money’ whereas the other partner actually runs the business.
  • Joint Venture — You might have situations where you want to pursue a project or initiative of some kind only on a temporary basis. Establishing a type of merger would be suitable as this can expire or dissolve over a period of time naturally. That’s what a joint venture is. It’s like a general partnership only with an expiration date.

You can see the varying characteristics. It’s important you know, based on your needs and what your company would be all about, what you’re looking for in a business partnership.

Of Course, Keep a Close Eye on the IRS

You are required to file as a business, both on the federal and state level. Do the research and make sure you have that tax ID number or permit available. This might throw you off, though, in that partnerships don’t even pay taxes!

Instead, you have what’s called an annual information return, something reporting your business income. Bear in mind that as individual partners, you must report your own individual tax returns. Another term for that would be, simply put, the “pass through” profit/loss.

Individually, you’ll be responsible for the Annual Return of Income, all taxes on Excise and Employment, Income Tax and also Self-Employment Tax. You’re going to need the Schedule K-1, which is the Form 1065 for partnerships. That’ll be your “W-2,” basically.

All of it is very different, but essentially the same — you’re still filing as an individual, but you have some extra forms that you’ll need to be aware of, that and also these warnings, too –

What Warnings? Or Disadvantages?

There are some drawbacks to the business partnership, such as personal rivalry. In other words: mixing business with friendship (or family) can be a playing-with-fire event. Be careful. Running a business is stressful enough. Running it with your friend or spouse (even worse) can throw more fuel on the fire. This is just on the personal level, though….

What about legally? The worst thing you can think of when dealing with a business partnership is liability. Who’s at fault? The problem with partnerships is that you don’t require any incorporation documentation at all. Essentially, partners share the liability equitably. In that same vein, success and profit is also shared equally, no matter just how much effort or investment is put into the business by either partner. Look at it as a disadvantage, because oftentimes it is such.

So You’ve Got to Know When to Quit

Growing pains occur. Understand that oftentimes a business partnership is just a part of those growing pains, and there may be a time when the partnership must dissolve. The key is knowing when to dissolve it. There are factors you can observe, such as:

  • How many ‘partners’ do you now have?
  • How much of a liability risk are you now?
  • Do you need a financial lender for more capital?

In essence, if your company’s getting bigger, so will your liability. Your need for capital will grow. Certain tax benefits outside of the realm of a business partnership may be your best bet.

In the End, It Shouldn’t Be About You — But About the Common Goal

You entered into a partnership to serve a purpose, not yourself. If you were going into your business with someone else just to get some kind of benefit, stop. Rewind. Start over. Those are the kind of partnerships that’ll fail.

As always, discuss corporate prospects in-depth with your qualified business lawyer, and see what might be best for you. If you’re willing to work with a partner, knowing that your business is something more than just yourself, then go for it! You might discover that it’ll be the best decision you ever made.

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