Welcome back to part two of our four part series on business formations. The purpose of this series is to provide enough information to allow you to one, make an informed decision on how you should operate your business or two, be in a position to ask better questions when you meet with your attorney and your attorney and your accountant to decide what’s the best business formation for you. And I say and because you need both an attorney and an accountant because the attorney can tell you from a legal standpoint how you should operate and what’s going to be best to achieve your goals. And then the accountant or the CPA can tell you from a tax perspective on what’s going to be best for you to meet your goals.
Because when we’re talking about best, it’s really subjective. What’s best for you may not be best for the next person. That’s all going to be dependent on your goals and what your long-term vision is for your company.
So last week in part one of the series, we talked about sole proprietorship and what we were able to do during that series is really get clear on what business is and what is isn’t. So if you haven’t listened to episode 118 of the podcast, go back and take a listen to that.
We’re gonna keep it moving and we’re gonna keep it moving in the same format as we did last week. We’re gonna talk about the what, the how, and the why. A partnership, this week we’re talking about partnerships. So what is a partnership? How is a partnership formed? And why do some people choose partnership based on the pros and cons of that formation? You ready? Let’s do it.
So partnerships are formed when two or more people come together to do business for profit as co-owners. Sound kind of familiar? It should. It’s literally a sole proprietorship, but with or more people instead of one. And it’s formed the same way. There’s no formal documentation, there’s no paperwork to file with the state, just two entrepreneurs who go together real bad. They’re coming together to do business.
In my opinion, partnerships are the easiest formations to cause confusion. And the reason I say that is because if you look at the definition the definition says two or more people coming together to do business as co-owners or who makes that decision. Who decides that these two people are coming together with the intent with the intent of being co-owners? And if you don’t have a written agreement things can get heated real quick and I think about Mark Zuckerberg when he created Facebook. When he was building it, in his mind, he was doing this project solo. He’s building this business on his own, but he was seeking help from other people. I wanna say they were twins. But in the twins mindset, the three of them were building this platform together. So just imagine their surprise when they are written out of the business, kicked out altogether because they were never partners.
And that’s why it’s just important. Like when you’re working with third parties, use contracts. Be very clear on the nature of your relationship so you don’t have this confusion. And once you’re clear, once you have this conversation, put it in writing. Because yes, you can have this conversation verbally, but it’s really great to be able to refer back to something and say, hey, this is what we stipulated to, this is what we said back when we first started working together and that can come in handy down the road, you never know. Anyway, this is not a podcast on contracts. We do have one on contracts. You can go back and listen to it. I don’t have the episode number.
But, I’ll say one more thing when it comes to contracts. When you’re in a partnership, contracts are your best friend. Remember the whole being personally responsible for your business liabilities. Like when you’re a sole proprietor, everything starts and ends with you, you and your business are one. Now, instead of it being the one, it’s the two or more, right? So the same rules apply to partnerships and you’re going to be liable for not only your actions, but also your partner’s actions too.
If they decide that the company needs new fancy equipment to operate and they open up a line of credit for the business to do so, guess what? You’re on the hook whether you agree to or not. And so while partnership agreements, they’re not required, I strongly, strongly recommend it because the written agreement can create limitations on what the partner can and cannot do as it relates to the business and if they act outside of this agreement, then it will be a breach. And the other partner, the one who’s not in breach, may be able to avoid liability.
And here are some things that a partnership agreement should specifically address. It should address how the day to day of the business will be ran, how decisions will be made, how conflicts will be resolved, how new partners will be added, what happens if a partner wants to leave and the roles and responsibilities of each partner. And that’s not an exhaustive list, that’s just a few things that you should be having a conversation about and then putting in writing once you come to an agreement.
Now, this is where partnership’s different from self-proprietor, you know, there’s only one type of self-proprietor is just you doing business for profit, right? But partnerships, there are a few different types and we’re going to talk about those. You have general, you have limited, and you have limited liability. You have the three partnerships. And what most people, when most people think about partnerships, they think of general partnerships. And these relationships and this general partnership relationship.
Each partner equally shares in the profits, liabilities, and ability to bind the partnership. They have equal say so, they get equal part of the profits, they’re equally responsible for the debts.
On the other hand, a limited partnership allows a partner, or partners, depending on how many you have, to act in a capacity of what you call a silent partner, where those people, they contribute financially, but they really don’t have a say in the day-to-day.
So what that looks like is them putting their money and then taking a larger percentage of the profit based off how much money they put in. With the understanding that they just here for the money. You don’t have a say in what we’re doing in the day to day.
And the purpose of this is so that the partnership is able to–the purpose of this is so that people can invest in the business because they’re you got to find alternative ways to get that money when you’re a self-proprietorship in a partnership. So this being a limited partner is one of those ways.
On the other hand, a limited liability partnership, which sounds like, wait a minute, isn’t a limited liability partnership similar? Like, isn’t it the same thing as this limited partnership? The main difference is that this limited liability partnership was really made for professionals like lawyers and doctors and accountants, those who have to deal with malpractice. And what they don’t want to do is be responsible for the negligence or misconduct or malpractice of their partners. And so they formed this limited liability partnership, which allows each of the partners to only be responsible for their own misconduct, negligence, malpractice.
However, so that’s just as it relates to the misconduct and stuff, right? Which means that if there’s a lawsuit or anything of that nature that’s as a direct result of this misconduct, malpractice, or negligence, then that partner is responsible for their own debt and all the other business debts that just rise out of normal cause of business is the responsibility of each of the partners equally.
And what it does is it allows professionals to practice as partners without worrying about going in debt because their partner’s potential misconduct.
So we got that, we have partnerships, we have that partnerships are basically self-proprietorships, but with more than one person because the liability is the same where you in that business liability, you run neck to neck, like there’s no, nothing, we’ll see, no buffer, right? But there are different types of partnerships and we talked about the general, we talked about the limited, and we talked about the limited liability partnership.
So let’s talk about why would anybody, especially with now, listen, I’m not just responsible for my stuff, but also your stuff, why would anybody want to choose to operate as a partnership?
I have four reasons. Let’s get into them. The first reason that someone might wanna form a partnership is because, listen, you get to share not only the expense of running a business, but also all of the responsibilities. Everything is not on your shoulders anymore. And that can be a relief.
Especially when you’re not the only person planning. Like I know for me the biggest challenge of being a solopreneur is having someone to bounce ideas off of. Someone that knows and understands the business and sees the vision and knows that we can plan to get there. That’s one of the most challenging parts for me as a solopreneur and having a partner would help alleviate that.
Similar to partnerships–similar to sole proprietorships, forming a partnership is so easy. No formal documentation, nothing to file with the state unless you are a limited, if you are a limited partnership or a limited liability partnership, you do need to file with your secretar. But other than that, if you just forming a general partnership, easy breezy, right? And it’s cheap because there’s no additional paperwork to file. So that’s reason number three. Reason number one, is you get to share the responsibility. Two, it’s easy to form. Three, it’s low cost. And four, the ability to take on more opportunities because you’re not doing all of the things. Because you’re not doing all of the things, now you can take on more clients. You just have more space to grow and build. So those are four great reasons of why you would want to form a partnership.
But, with all things, you know, you have your pros and you have your cons.
So let’s talk about the consequences of operating as a partnership. Number one, you have to consult with another person before making a decision. And if you don’t play well with others, this could be a problem. Two, you are personally responsible for the decisions your partner’s making in the business. Three, it can be difficult to get out of the business. If you decide that, Hey, I want to sell the business. You have to get, again, get your partner’s permission on selling or even if you want to bring somebody else in, you got to seek, you got to seek permission. Like it can be difficult to unwind and figure out, especially if you have a partnership agreement and you’re going through the debts and you want to make sure that the debts are in line with this agreement. So what you’re responsible for, but the business response for but this other partner I’m responsible for based on this agreement it gets to be difficult to get out of and for that profit that you’re that you’re seeing now you have to share it with your other partners.
I don’t know–I just I don’t know the image I had was the band group the boy band groups you know there’s always like a thousand of them in the group and they always have to like split the money between them anyway that’s what we’re talking about this week. Partnerships, I hope you learned something. I view partnerships similar to marriage. You have to choose the right partner and you have to communicate clearly and often.
How do you feel about partnerships? Let me know in the comments.