Team

Partnerships

Partnerships can serve as a powerful tool when building a business.

Getting them right takes good alignment in goals and values, honesty, hard work and clear communication.

It also really helps to write things down in an official agreement.

Types of Partnerships

General partners are involved in the day-to-day work of the business and usually share in the liabilities.

Limited partners have an ownership stake, usually as a result of an investment, but they don’t work in the business or share liability.

What do partnerships bring to the table?
Knowledge, skills or expertiseValuable connections or relationshipsAssets including patentsMoney or access to investors

Taxes

Business partnerships are taxed much like LLCs. The partners or owners report business income or losses on their personal tax returns. The business itself doesn’t pay taxes on profits but “passes them through” to the owners.

Partners aren’t considered employees, but rather pay income tax based on the share of profits and losses distributed to them during the year. Partners must also pay self-employment tax for Social Security and Medicare based on their share of profits.

To enable and substantiate this, a Schedule K-1 is distributed to each partner

The partnership must also file an informational form, Form 1065, with the IRS.

Ownership

Most businesses are owned by a single individual, but partnerships are also common across business types.

<10% of businesses are started by teams of non-relatives

Business Ownership Breakdown
73.64%

Businesses have 1 owner

22.29%

Businesses have 2-4 owners

1.18%

Businesses have 5-10 owners

0.50%

Businesses have 11 or more owners

Spouse Ownership Breakdown
72.97%

Businesses jointly owned by a spouse

27.02%

Businesses not jointly owned by spouses

Partnership Agreements

Overview

There are different types of partnership agreements, but they all require a contract. A contract states the terms of the partnership, including the structure of the business relationship and its intended benefits and obligations. It includes:

  • Percentages of ownership and distribution of profits and losses

  • Partners’ roles and responsibilities (such as management structure, decision-making power and day-to-day duties)

  • "What if" situations—particularly organizational changes like someone leaving the partnership–—that can cause confusion and disagreement

What happens if you don’t have a partnership agreement?

If you don’t have an agreement in place, your partnership will likely be governed by your state’s default legal code for partnerships, based in common law.

In most states, this is the Revised Uniform Partnership Act (1997), which tends towards requiring that all partners share equally in the management, profits, losses, investment and contribution of services to the business. Given that this is rarely how most businesses actually work, it’s important that you create a partnership agreement now to avoid problems down the road.

Creating an agreement

Whether you’re just starting out or you’ve been in business together for years, it’s never too late to create a partnership agreement (which we recommend for all partnerships). You have three options:

  • Do-it-yourself based on a partnership agreement you find online. But for any partnership in which you are going to invest time and money, it’s worth having an attorney take a look as well.

  • Hire an attorney to either review your template or draft up a new agreement based on your specific business needs.

  • “Use an online legal service that provides templates along with some basic guidance for a fee.

See our Legal Services Buyer’s Guide

On the next page, we’ll go over what information to include in your partnership agreement.

The Basics

  • Partnership business name

    This may seem obvious, but can have many critical components (including fictitious business names/DBAs and branding considerations).

  • Business address
  • Partners’ names
  • Effective date

    When the agreement starts

  • Term of the partnership

    When it ends, if it’s not open-ended

  • Fiscal year

    Generally the same as the calendar year

  • Deadlines

    Critical for partner contributions

  • Accounting, auditing and record-keeping practices

    Particularly for tax time

The Details

  • Purpose of the partnership

    Contribution of capital, expertise, etc.

  • Partnership contributions and ownership percentages

    This could involve equal or unequal shares, depending on initial outlays of cash/capital or “sweat equity.”

  • Allocation of profits and losses

    This generally depends on ownership percentages. This includes “draws,” in which profits are allocated to one partner before a general distribution to all partners.

  • Partner authority

    The type of consent a partner needs before contractually binding the partnership. Options include majority vote or unanimity.

  • Decision-making power

    How major decisions are reached and what constitutes such a decision

  • Management

    It’s advisable to specify roles and responsibilities, such as if one partner is responsible for accounting, another for sales.

  • New partners

    Even if this isn’t going to happen soon, it’s a good idea to specify terms and conditions for bringing new partners aboard. This generally involves a partnership contribution.

  • Withdrawal or death of a partner

    This involves specifying how partnership interests will be valued and bought by one of the remaining partners or the partnership as a whole. (You may also want to consider key person insurance, which is simply insurance on a key person in a business).

  • Dissolution of the partnership

    Don’t enter a business arrangement without having specified an exit strategy. It may take place through unanimity, majority vote or single partner vote.

  • Conflict resolution

    Specify if you’ll seek out mediation prior to any legal action