Forming a partnership is often an ideal way to go into business if you plan to do it with someone else. You might have a family member or close friend that shares the same vision for starting a business and decide to go in together with a partnership.
Before you begin visualizing how you and your co-founder plan to take on the world with your startup, it’s important to understand what it means to start a business partnership. Some necessary areas to prioritize include:
- Picking a business partnership structure.
- Drafting a written partnership agreement.
- Obtaining a federal tax ID.
Let’s review what each of these items means when it comes to smoothly running a partnership together.
1. Picking a business partnership structure.
If you and your partner decide to form a partnership, you may be surprised to learn you can choose from several partnership structure options. It’s similar to forming an LLC, where you have the option to form a single member, member managed, or manager managed LLC structure.
Currently, there are four common types of partnerships. Let’s review each one.
- General Partnership. Most partnerships are formed as a general partnership. In this partnership, two or more partners establish an agreement for how they will run and operate their business. The agreement allows the partners to evenly divide profits, liabilities, and management duties among one another. Doing so ensures that all partners in the partnership are equal and fulfill equal roles.
- Joint Venture Partnership. This is a temporary partnership. It is formed by partners that wish to reach a specific phase with their business. Once they reach that phase or cycle, the partnership expires. Some instances where it may be helpful to form a joint venture partnership include speeding up certain business processes or completing a business development phase.
- Silent Partnership. Not all partners in a partnership want to be the face of their business. A silent partnership allows one partner in the business to be a bit less active. This partner will provide the business with capital but have less responsibility in running or overseeing the company. The other partner(s) will take on the responsibilities of the silent partner, in addition to their own, and divide them amongst other partners to be equal for all.
- Limited Liability Partnership (LLP). Certain professions that are licensed by the state, such as doctors, dentists, and accountants, will form an LLP. This structure is specific for these licensed professions. It helps protect partners from any consequences that may stem from the behavior of another partner, such as negligence or malpractice.
Now that you know which partnership structures there are to choose from, meet with your business partner. Discuss which option is the best fit for your business. Then, make a decision together. If you and your partner are still unsure of what to do next, meet with a legal professional to ask any additional questions and receive the necessary guidance moving forward.
2. Drafting a written partnership agreement.
Once you choose a partnership structure, it will be time to draft a written partnership agreement.
Most entity formations do have a written agreement in place. LLCs will draft an LLC operating agreement while corporations establish corporate bylaws. A written partnership agreement outlines key details about the partnership including who runs the business and how the business is meant to be run.
Here are a few additional areas a partnership agreement needs to cover:
- Term. This is the startup’s official start date. A partnership’s term includes the day, month, and year that the company is in business.
- Roles and Responsibilities. This section defines the role each partner plays in the business and their daily responsibilities.
- Capital. Each partner shares the capital contributions they plan to invest in the partnership. Additionally, you may include details about the bank account where this money is kept and how and when partners are paid. Terms of profits and losses for each partner should also be detailed in this section.
- Partner Admittance. Do you plan to admit a new partner? Instructions will need to be drafted for the admittance process.
- Partner Withdrawal. Some partners choose to voluntarily withdraw from a partnership. Others may involuntarily withdraw for several reasons. Like instructions created for new partners, a partnership needs to outline next steps for partners that withdraw or the passing of a partner.
Once you finish a written partnership agreement, review the draft with your partner(s). Make any edits necessary.
3. Obtain a federal tax ID.
If you don’t already have a federal tax ID — also known as an employer identification number or EIN — now is the time to file for one.
An EIN is a nine-digit number issued by the IRS to businesses. It works to identify and track employer tax accounts. You may also use an EIN instead of a Social Security Number (SSN) when filling out business paperwork.
Having an EIN is critical in a partnership for this specific reason. Most partnerships have two or more members. This makes it impossible to use a partner’s SSN on business paperwork. However, once you obtain a federal tax ID you may use the EIN on legal documents and any other partnership documentation.
Are written partnership agreements the same as business plans?
Remember that the purpose of a written partnership agreement is not meant to be like a business plan. A business plan looks to the future of the startup and the milestones it plans to achieve. A written partnership agreement helps ensure all partners can run the business smoothly together.
Let’s say that you plan to go into business with your best friend or closest confidante. You might have a long history of always getting along, but it is possible that an issue may come up or there may be a conflict between partners.
As such, it never hurts to come prepared in business. A written partnership agreement clearly defines what each partner contributes to the company, provides an understanding of what each person does, and works to protect the partnership.
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