What You Should Know Before Forming a Business Partnership Aura Image Consulting
What You Should Know Before Forming a Business Partnership

What You Should Know Before Forming a Business Partnership

Comparing a business partnership to a marriage is cliché, but it is also accurate. In what other circumstance would you spend the majority of your time with a person, share a source of income with them, and agree to long-term commitments? Sounds a lot like marriage, minus the obvious perks. You wouldn’t marry just anyone, and you shouldn’t go into business with just anyone either. Here are a few things you should know before forming a business partnership.

 

Business Prenuptial Agreement

Officially called Business Partnership Agreement, a Business Prenuptial Agreement is the first legally binding document you and your partner should sign together. It is a basic summary of what you should expect from each other as business partners. There is no uniform agreement, as they vary by state. There are also a number of other agreements that ought to be added to this brass-tax prenup like:

  • Management agreement
  • Contributions agreement
  • Dissolution agreement

 

Exit Strategy

On the topic of dissolution, you may not feel like “going there” during the honeymoon phase of building your business. But the fact is, you could find yourself in an unforeseeable position tomorrow that forces you to leave the company. The same applies for your partner. Life-changing events to plan for in an agreement are:

  • Death
  • Disability
  • Buyout

 

Note that it is good to write out a whole agreement for buyouts. A buyout agreement covers what happens if a shareholder wants out. How will a partner be compensated for shares left behind? Provide as much detail as possible in the beginning of your business venture so that things go smoothly when the time comes to go your separate ways.

 

Equity

Generally speaking, a colleague becomes a partner when you offer them equity. Much like tenure for academics, equity usually spans the lifetime of a company. There are exceptions to the rule, and you may want to consider an option that allows your partner to surrender her shares if she were to leave the company. Known as an equity pool or option pool, alternative equity is especially attractive to young talent, as they tend to be less settled and less willing to sign onto commitments. Because the shares are sourced from investor stock, the number of shares disbursed from an initial option pool is established after the company secures its angel investor.

 

Whichever model of shareholding you choose, if you are the company owner, your partner should never own more than 49%.

 

Taxes

As individuals, your taxes are filed separately, but you will have to submit a form that records the earnings of your partnership. IRS form 1065 is an annual tax return that is used for informational purposes only. Form 1065 records the financial operations of a business partnership. No action is taken on behalf of the IRS. However, the income of the partners involved is taxed separately.

 

Too Many Cooks or Not Enough?

Before you commit to a business agreement, think about the motivations behind your decision. Make sure that your partner is needed to reach your business goals and expectations. This will help you understand and communicate what you and your partners’ respective roles are in the company. Clarity is essential to any relationship, especially in a business partnership when so many financial ties are made.  

 

Careful What You Wish For

Once you have defined those clear roles, make sure your partner is on the same page. The last thing you need is a disgruntled or vindictive partner who will look for any opportunity in the future to assert dominance or power. Speaking of, how you resolve disagreements should be covered in a signed agreement. Points to consider when it comes to difficult communication:

  • Will you settle legal disputes with customers as a team or separately?
  • Will you seek arbitration if you have a dispute with each other?

 

If the worst case scenario happens, find a lawyer specializing in your business. Nobody wants to have to go to court and in many cases, you’ll have the opportunity to settle outside of court, however.

What You Should Know Before Forming a Business Partnership

Establish a vision

You can do this together or separately, but make sure you are honoring your business goals no matter how you get it done. You may feel financially savvy on your own, but having a partner is a game-changer. Address the nitty-gritty that you may want to put off until you don’t have a choice but to deal with it. How will you manage business expenses? How will you be expected to contribute to the business?

 

Structure of your Partnership

How much responsibility business partners take on within a company usually informs what kind of partnership is entertained. There are 3 basic partnerships:

  • General partnership, which determines even roles between partners
  • Limited partnership, which determines uneven roles between partners
  • Limited liability partnership, which determines even roles with limited personal financial responsibility

 

Speaking of financial liability, drafting an agreement around potential company debt is paramount, especially in the beginning stages of a partnership when the topic is as emotionally neutral as it will ever be. With this in mind, you may want to explore your partner’s credit history before you jump into business with them. Do not feel bad about it. You would hope your partner is acting as cautiously and checking your credit score like you are theirs. You would not want to lose your retirement savings over a poor decision you could have anticipated.

 

Conclusion

Be cautious. As good as you may feel right now, protect your business interests by thinking ahead and processing legally-binding contracts.  

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