What is a Business Partnership and What Should You Consider Before Entering One?

Any business owned by more than one person is a “partnership.” I’m not gonna lie to you, either, business partnerships are tough! With the right preparation and guidance, though, it’s doable, and it can even be beneficial. Let’s dive into it!  

What is a Business Partnership? 

Any company that is owned by multiple people is technically a business partnership. This is most businesses. A business owned by a married couple is sort of a partnership, too, albeit it is less difficult to work with (I hope!)

What Should You Consider Before Entering a Business Partnership 

There is so much to consider before entering into a business partnership that it might be better to just say what NOT to consider! Here’s a short list of the main things you should go through before entering into a business partnership:

• How well do you know your to-be business partner(s)? And I mean, how well do you really know them? People can make things look very different from how they actually are, in reality. Numbers are hard to fake, though. You should think like a bank does. You can’t really “charm” a bank into giving a big loan for a company that doesn’t have the proven ability to make profits. It’s great if your to-be partner is a cool person that you want to be friends with, but being business partners is an entirely different thing, don’t get them confused!
• Is the business already working, or are you starting it out from scratch?
• If the business is already working, why are you being asked to come in on the business? If it’s money, then why does the business need money? Is it not doing well and needs money? If so, that may not be a great investment for you! If it’s for your labor (AKA “Sweat Equity”), then how much of the business ownership will you get for your “sweat?”
• How much of a vote would you have in terms of the business’s decision-making?
• Is your partner-to-be a good and proven entrepreneur? What’s their track record? What’s your track record?
• Has your partner-to-be had partners beforehand, and if so, can you interview them? Are they still partners?
• Do you need this business partner, or could you do it on your own? What would that look like?
• What would happen if you and your partner had a falling out? How would your family be affected? Your friendship with the partner? 

Tax Implications 

Businesses can be completely different from a normal tax return filing. For example, many business owners are taxed on all of the profits a business makes, regardless of whether that money was paid to the owners! Why is that important? Well, startup businesses are usually cash “poor” and need to keep all of the money they take in. That means that the business is unlikely to be able to pay the owners much of anything for the first year or two. Sadly, the IRS doesn’t care and will usually tax the owners on those profits, even if the business owners haven’t seen a dime hit their personal bank account. 

This tax liability can also be used as a sort of cudgel to push out business partners who can’t afford to pay the taxes, but still deserve to be owners of the business. It’s sad, but it’s true, and I’ve seen it a lot. Be prepared for your taxes in the first couple of years. 

Sometimes, business partners can prevent the business from paying you anything (they can limit what are called “distributions”). They can do this even if it’s not “fair,” in order to manipulate you out of the business, or to agree to other business decisions that you wouldn’t otherwise agree to. 

Credit

You will want to figure out who will be “personally liable” for the business’s accounts. This includes bank accounts (whose name is on it) and any credit you get for the business (credit cards, lines of credit, business loans, equipment loans, loans from family and friends, etc.) I’ve seen many business owners take out a great deal of debt for the company, pocket it, and then leave the business (and their partners), who then have to pay off all of the debt, unfairly, or their own personal credit will get wrecked! Again, this probably sounds unfair, and you may be thinking, “My business partner would never do that!” But, well, never say never; people do crazy things!

Roles and Expectations 

Figure out who will be doing what. I like to lay out ALL of the tasks that the business will need done, the amount of work hours it will take, and then divvy up the tasks in a balanced manner. It is possible that one partner is only investing money while the other is investing time. That’s fine, if that’s the expectation and everyone understands it going in, but these things need to be hashed out well before money starts coming in (or going out). The sweat equity person’s workload should be within the range of the monetary investment the “money partner” is giving to the business. 

Find a Trusted Business Attorney

I can’t emphasize this enough; you don’t know what you don’t know. I’ve advised business partnerships for over 12 years, and I’ve seen a thing or two. I know what to look out for and what’s not a big deal. I can spot red flags that others just don’t see. Hire an attorney to help. Setting up a good partnership agreement early on, before money is involved, will make a business. Failing to set it up the right way will break the business–it’s just a matter of when.