When it comes to deciding on a business structure, be it an S-Corp, C-Corp, or partnership, you’ll need to weigh the pros and cons of each type of business. Partnerships are a common choice due to the low start-up costs, minimal paperwork, and simple set-up process. The following guide will show you a few simple steps to start a partnership.
What is a partnership?
A partnership is an unincorporated business structure that is formed and owned by two or more parties. These parties are referred to as partners, and they may be corporations, individuals, legal entities, or other partnerships.
The parties in a partnership may contribute skills, labor, capital, and experience to the business. Additionally, they may have unlimited legal liability for the actions of the partnership itself or its partners.
The most common type of partnership is a general partnership which involves a general partner who manages and exercises control over the operations of the business actively.
Limited partners, on the other hand, have limited legal liability and cannot exercise control or management over the business.
Some of the most common types of partnerships are limited partnerships, limited liability partnership (LLP), and general partnerships.
Something else to note about partnerships is you can start one without a written or oral contract. When a written contract is involved, it is referred to as a partnership agreement. The contract between these partners ensures that everyone involved agrees on the purpose of the partnership as well as the responsibilities and rights of each partner.
Additionally, a partnership splits both the profits, business debts or company debts and losses among partners. They are responsible for both filing and paying taxes for their portion of the partnership profit. Partnerships are very similar to joint ventures where two partners or typically corporations engage in business together for profit or nonprofit.
Who should start a partnership?
A partnership is necessary if you plan on running a small business with no more than 20 people. In this case, limited liability is not necessary. Partnerships are easy to set up. You’ll need to form a private agreement between yourself and the rest of the partners you plan on going into business with.
However, with a partnership, you won’t need to register their existence with the state like you would with other business structures like limited liability companies or corporations.
Consequently, partnerships are just as easy to dissolve as they are to set up. Any partner wishing to end their agreement will need to give an express notice of their will to leave. There’s also no business tax return, and partners need to report profits on their personal tax returns or partnership tax only.
There are various options when starting a partnership, including creating your partnership as a general partnership, limited partnership, or joint venture. Additionally, each partner has a duty of loyalty to the partnership itself, ensuring that each partner does what’s in the best interest of the partnership and not their own personal interests.
If the above-mentioned benefits of a partnership sound appealing to you, then this business structure may be the best option for you.
Advantages of a partnership
Partnerships, like any other business structure, come with a set of advantages. Let’s take a closer look at them below:
While a sole proprietorship is essentially the same business structure as a partnership, partnerships offer the advantage of allowing partners to draw on the expertise and resources of their co-partners. This is because running a business can be a constant struggle, especially when doing it on your own. However, when you have partners, they share the responsibilities with you and ultimately lighten the workload. Therefore, by forming a partnership and having partners involved in the business with you, you have more time to dedicate to other activities.
Acquisition of capital
Businesses formed as partnerships have a much easier time accessing capital as compared to corporations since partners who apply for loans as individuals can usually get loans on better terms. One of the reasons why this is so is because partners guarantee loans using their personal assets as well as those of the business itself. When it comes to the granting of loans to partnerships, banks tend to be more lenient as they consider partners to be less risky than corporations since corporations only need to pledge the business’s assets. Additionally, you can attract investors by forming a limited partnership since investors are not usually actively involved in the management of the limited liability, and there’s also no need to form a corporation and sell stock.
Partners report taxes on their individual tax returns for the profits passed through to their owners. In this case, the profits are taxed just once at the personal level of its owners rather than twice, which is the case with corporations and some other business structures. The other business structure that allows you to have the same benefits of single taxation is the S corporation or limited liability company.
The laws governing business entities such as limited liability companies and corporations vary from one state to the next and are constantly changing. However, the Uniform Partnership Act offers a consistent set of state laws pertaining to the formation and management of partnerships that make it easy for small business owners to become acquainted with the laws that radically affect their business. The UPA also ensures that business is much easier between states since they have been adopted in all states, with the exception of Louisiana.
Simple operating structure
Partnerships are fairly simple to create and manage in the long run. There is no need for formal agreements or any type of forms, such as Articles of Organization to be completed, although it is advisable to write a partnership agreement to avoid future disagreements. One of the prerequisites to starting a partnership is filing a partnership certificate with a state office in order to register the name of the business and also secure a business license. This is also one way to avoid the annual filing fees associated with other structures like corporations.
In the case of a small business, the owners of a partnership also manage it, and therefore, the company is straightforward to manage, and the decision-making process is quick, avoiding bureaucracy. When compared to corporations that have shareholders, officers, and directors, the process is not as simple, as all of the members involved have a certain degree of responsibility when it comes to making major decisions for the company.
Disadvantages of a partnership
Partnerships, like any other business structure, come with a set of disadvantages. Let’s take a closer look at them below:
Conflict with partners
Collaborating with co-partners tends to be a huge advantage to small business owners; however, running a business every day with co-partners can turn out to be a nightmare.
One of the reasons for this is that you have to learn how to compromise by giving up absolute control of the business. Disagreements are common when big decisions need to be made, and everyone has a different opinion on the best course of action. This is when a partnership agreement can come in handy.
One of the drawbacks of the partnership is that since there’s no separation between the owners of the business, the assets of the partners are vulnerable and subject to personal liability. By forming an LLC, or incorporating limited liability companies, the owners of the company are afforded liability protection ensuring they are protected from the unlimited liability that is the main drawback of partnerships and sole proprietorships.
Limitations on the transfer of ownership
The existence of partnerships depends upon the owners, unlike corporations which exist independently of their owners. Consequently, the Uniform Partnership Act states that ownership may not be transferred without the consent of all the other partners.
Vulnerability to death or departure
In the case of general partnerships, if one of the partners dies, withdraws, or retires, then the business dissolves. Corporations, on the other hand, exist perpetually.
Authority of partners
Each partner in the partnership is legally bound to fulfill any contract that one of the partner’s signs. Essentially, what this means is that each partner is responsible or liable for every other partner’s decision.
Steps to starting a partnership
As is the case with all business structures, when it comes to forming a partnership, there are a few steps that you need to follow in order to get your business up and running:
1. Choose your partners
When it comes to starting any business structure, choosing your partners wisely is imperative, as you will be working closely with them. Considering partners means that you need to look at things like knowledge, skills, and credibility.
2. Choose your type of partnership
There are multiple types of partnerships to create, including a limited partnership, a general partnership, an LLC partnership, and a limited liability partnership.
3. Decide on a name
Once you’ve decided on a partnership type, it’s time to start thinking about a name for your business. Your partnership name may incorporate the names of the partners, e.g., Mellen and Brown. When deciding on the general partnership as a structure, the name should normally include a combination of all the owners’ last names. Additionally, ensure that the names are not already taken by another business entity. It’s also important to note that some states have specific requirements for partnership names, so do your research before moving forward with a name for your partnership.
4. Register the partnership
After you’ve decided on a business name, it’s time to register it with your state. In most cases, you will be able to register your business online via your Secretary of State’s website. If you plan on doing business in more than one state, then you need to register with each of those states.
5. Determine tax obligations
In order to make sure that you’re compliant, ensure that you are fully aware of your tax obligations. Partnerships file business taxes using Form 1065, US Return of Partnership Income. The form is used to report profits and losses to the Internal Revenue Service (IRS).
6. Apply for an EIN and tax ID numbers
Every member of the partnership is responsible for paying taxes on their income (income tax) from the partnership. You need to apply for a tax ID number and an Employer Identification Number for tax purposes.
Depending on the location of your business, you may need to acquire the following:
- Federal tax ID number
- Business tax ID number
- Local tax ID number
- State tax ID number
7. Consider a partnership agreement
A partnership agreement allows you to narrow down the responsibilities, goals, and liabilities of each member of the partnership. It’s similar to an operating agreement. It’s also a legally binding contract that you refer to during conflict in order to find resolutions.
8. Obtain licenses and permits
Prior to running a business, you may need to obtain specific permits and licenses depending on both local and state requirements. Some of those permits and licenses include a sales tax permit, business license, resale certificate, building permit, DBA license, or industry-specific license.
9. Open a corporate bank account
Opening up a corporate bank account ensures that you do not mix your personal and business funds. To keep your partnerships’ finances separated, create a separate bank account for the business. In order to open up a bank account for your partnership, you’ll need to provide your EIN, your partnership agreement, and your business name filing document.
10. Choose an accounting option
Sit down with your partners and decide which route is the best option for managing your books. You may choose to go with manual record transactions, hire an accountant, or use accounting software. Whichever option you take, ensure that you have a way to not just track but manage books.
A partnership agreement is a legally binding contract that you should consider to help avoid conflict and bring resolutions to disputes and disagreements.
S corporation owners pay slightly fewer self-employment taxes, offer protection of personal assets of their shareholders, and have a straightforward transfer of ownership.
When it comes to an LLC vs. partnership, LLCs are considered legal entities on their own, while partnerships are owned by two or more people who share the legal responsibility of the company.
LLCs are not partnerships. However, many LLC owners refer to their co-owners as business partners.
Each member of the partnership or co-partner contributes property, money, labor, or skills towards the business, and the partners share in the profits and losses of the company as well.