You’re best friends. You have great ideas that run in similar veins. Why not start a business together? While great partnerships can become legendary, all too often they hit rough patches. With so much of each partner’s livelihood tied up in another person, it is important to know the full extent of what you are getting into before you commit.
We like to compare a partnership to a marriage. So often we would sit down with people starting a partnership and say, so what happens when it goes south? And always the response was, “we’re great friends, we’ll work it out.” And within a year or two, most of those people would be back in our office, trying to break up the partnership and fighting about who gets what. The beginning of any partnership is the dating period. You are so in love with the idea, that you don’t worry about what comes at the end. Then you start it, and you hit the honeymoon. But once the reality of keeping books, having meetings, hiring and firing staff, expenses going out, and all of the other components that go into running a business happen, things can come crashing down. No one goes in a marriage thinking about divorce. But in a partnership, you must think of the end at the beginning. There are a number of steps to flushing out the partnership and ensuring that you begin on equal footing.
First, be honest about what each of you bring to the table. Put a value on that. Nothing kills a partnership sooner than one person feeling like they brought everything to the table and the other person just hitched a free ride. Maybe one person is the capital and one is the labor. How much labor equals the capital? If you’re going to go for loans or credit in the future, know what each others financial abilities to personally guaranty payments are. You don’t want to find out down the road that the other person limits your ability to get funding. You also don’t want to have your partnership assets levied on their dues. Who is going to be responsible for the books, the staff, the manufacturing/purchases, the sales, and so on. How much time will each of these items take? Is the division fair or equitable to both parties?
When looking at the partnership agreement, be sure to set a period of time where the books and records are frozen for use in determining the partnership’s value. This will be a key point for any future dissolution or sale of the partnership. Setting a way to value and split the partnership while you are still amicable will save time and attorneys’ fees later. Also, let’s remember those “kiddos” that come from the partnership. Who gets what assets during the split? If one person wants to continue the partnership, do they buy out the other person? How does it all work? And of course, you must think about death. Be sure to have terms outlining what happens if one partner passes away. If you haven’t thought through how to handle the buy-out of the window/er in a community property state, you need to. After all, you love your godchild, but maybe the generation gap is too much. You may not want to have a new partner thrown in the mix that comes from the inheritance of your partner’s estate assets.
And lastly, you need to consider taxation. What works for one partner may not work for the other. Maybe one partner can handle the estimated payments that come with receiving a guaranteed payment but the other needs to have the routine of payroll taxes? Should the company pay its own taxes and be separate from the partners? And those pesky distributions that must follow IRS code. These items come into play when determining the entity and tax structuring of your partnership. You can’t just look at the legal ramifications, but also what will happen on April 15th. Proper entity selection and tax classification will be a blog all on its own – it’s that big a deal.
There are many ways to determine if a partnership is right for you both. And other options of how to work together that aren’t as intertwined in legal and economic bindings. All of these are important factors, along with many others, that need to be determined and fleshed out before you shake hands and walk into the unknown. But if it’s done well, your partnership can certainly live long, and prosper.