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The Legal Implications of Forming a Partnership

By James Magazine | Small Business

The Legal Implications of Forming a Partnership image chamber partnershipThe Legal Implications of Forming a Partnership

Starting your own business is one of the most exciting steps an entrepreneur can take. For many it marks the point at which an idea becomes reality – and the type of business you choose to start can have a big impact on the company.

Some start ups are easy; a sole proprietorship requires little more than for an individual to register a business, and the company is de facto a sole proprietorship. Personal and business finances can mingle freely and business taxes – and losses – can be offset by income earned elsewhere. A limited liability company (LLC), on the other hand, offers legal protections of your assets should trouble arise, and also allows business taxes to “pass through” to your personal tax report – meaning lower payments. LLCs can also have more than one owner and, unlike sole proprietorships, sell shares to raise money. LLCs also allow “special allocation” of income – meaning that owners can divide up the profits as they wish, disproportionate to percentage of ownership, should you wish.

And then there are partnerships.

Going into business with a friend or colleague can be a great experience, but it’s always sensible to protect yourself. Partnerships are the only type of business that can be founded by oral agreement alone, but this doesn’t mean that’s always the best choice. A formal partnership agreement signed by both parties will provide you both with protections, clear business boundaries, and (importantly!) a clear guide to profit-sharing. A general partnership makes both parties owner managers, meaning that decisions need to be made by agreement or by a majority decision, if you have shareholders.

One thing to note straight away is that unlike LLCs, partnerships offer no protection against persona liability for debts or losses. Both partners can also be held responsible for the actions of just one party, making trust important – but a written, signed agreement vital.

What should a partnership agreement look like?

Remember that it’s always best to consult an attorney for legal advice and to help plan out your agreement.

The U.S. Small Business Administration offers a Model Partnership Agreement. Not every partnership requires such a technical document, but general areas to cover include:

  • The purpose of the business
  • Ownership interest – Whether 50/50 or otherwise, state each partner’s share of ownership clearly
  • Initial capital – If the business needs more money, who will it come from?
  • Salary/Profit distribution –If one of you wants to withdraw money or recoup investment how will this work?
  • Decision making and voting rights – If you disagree and reach a deadlock, an approved third party with a 1% interest can prevent delay.
  • Withdrawals – If one of you leaves, how will purchase price be worked out, and when will money be owed?
  • Death/Disability – What happens to a partner’s shares and capital?
  • Partnership Termination – If the business needs dissolving, you need strategies in-place to do so.

With these issues settled in a clear agreement, partnerships can save themselves a lot of headaches down the road. No matter how close to someone you are, going into business has legal and financial ramifications, and it is always better to be safe than sorry.

And finally – good luck!

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