You have been working with a business partner or partners for a while and you have decided to start a partnership. Great!
Any business with several owners is going to be more complicated than a one-person business, but by following these seven steps you can make the process quicker and easier for you and your partner or partners.
What a Partnership Means
A partnership is a business organization with two or more persons as owners. Partnerships are governed by state laws, and a new partnership is registered with the state where it will be doing business.
Each partner shares in the organization's profits (and losses) and may share in the business operations decisions.
For tax purposes, the partners are taxed, not the business itself. That is, the partners pay their share of the taxes based on their share of the partnership, through their personal tax returns.
Before You Go Into a Partnership
Before you decide on who will join you in a partnership, you should check out these potential partners. Even if you have known someone from kindergarten, it's a good idea to make sure they are good partner material. That means, for each potential partner:
Doing a credit check on each partner. Use one or more of the credit agencies (Experian, Equifax, or TransUnion) to run a credit check.
Check the person's online presence. What social media does this person use? What types of activities or photos do they post? Is there something you wouldn't want clients or customers to see?
Do a personality test on each partner. A personality test like the Meyers-Briggs Type Indicator can help you look at partners and potential issues with interactions.
Step One: Make Decisions About Partners
You may be starting your partnership with one or more other owners. There are several decisions you will need to make about the roles, responsibilities, and payments regarding these members.
How much does it cost to join this partnership? Usually, when a partnership is formed or a new partner joins, that person contributes a specific amount of money toward the partnership. You will need to decide how much each initial partner must contribute, and how much new partners in the future will contribute.
What types of partners do you want in your partnership? Are all partners the same, or do some have more responsibilities for day-to-day activities than others? A partnership can have several types of partners:
- General partners, who do the work and make decisions and have limited liability for debts and obligations of the partnership,
- Limited partners, who contribute but who don't make day-to-day decisions.
You may also want to have some partners put in an equity (ownership) share and other partners may be salaried (paid as an employee) because they are performing management duties. These two types of partners are called equity partners and salaried partners.
What part of the profits does each partner get? Profits of the partnership are divided between partners according to their contributions, seniority, type, or a combination of the above. Take 100 percent and divide it between all partners. The amount due to each partner is called a distributive share.
Of course, partners will share the losses of the partnership in the same percentage. This distribution is only for taxes; the amount each partner takes out of the partnership from this percentage is discretionary.
Step Two: Decide on Partnership Type
Based on the decisions you made in Step One, you should select a partnership type. There are several types to choose from.
- A General partnership has one type of partner, and all participate in the day-to-day decisions and the way their partnership share works are the same.
- A Limited partnership has both general partners and limited partners.
- A Limited Liability Partnership allows all partners to be shielded from liability for normal partnership activities.
There are several variations of partnership types that may be available in your state. At this point, you should check with your state's business division to see what types of partnerships are available.
Step Three: Decide on a Partnership Name
The type of partnership you have will determine the name of your partnership. For example, if you are starting a limited liability partnership, you would want this designation in your name. Some states have requirements for the name of different types of businesses, so this is the time to do research before you select that name.
A business name is a key piece of information for your business and it's difficult — and costly — to change, so make sure you are firm about your business name before you go on to Step Four. If you aren't going on to Step Four right away, you can just register your partnership name with your state. if you are registering soon, you don't need to register the business name separately.
Step Four: Register Your Partnership With Your State
When you have all the information you need for your partnership, go to your state's Secretary of State website and look for the business or corporations section. Here's where you register your business as a partnership. Most states will allow you to complete this registration online.
If your partnership will be doing business in more than one state, you will need to complete this registration process with each state. The main state is done first as a "domestic" partnership, then register in other states as a "foreign" partnership.
Step Five: Get an Employer ID Number
You can get an employer ID number (EIN) from the IRS after you have the business name and type and location. Almost all businesses need an EIN, even if they don't have employees. The process of getting an EIN is simple, and you can apply for an EIN online or by phone and get the number immediately
Beware of fake Employer ID Number application websites. They walk you through the process of getting an EIN, then charge you to file. The IRS NEVER charges for these applications!
Step Six: Create a Partnership Agreement
Don't skip this important step in starting your partnership. A partnership agreement sets out in writing all the processes and decisions that the partners have agreed to. It answers all the "what if" questions that could come up in the life of a partnership.
Step Seven: Get Other Registrations, Licenses, and Permits
Here's a quick list of some of the other legal and regulatory tasks you'll need to do as you start your partnership:
- Register with your state taxing authority for sales taxes if you are selling taxable products or services.
- Register to pay federal taxes with the EFTPS payment system. This registration applies to the paying of employment taxes if you have employees.
- You will need to file a fictitious name (sometimes called a DBA for "doing business as") registration with your city or county.
- Finally, depending on what type of partnership you have, you will need to register with your locality to get business licenses and permits, depending on your business activities.
Getting Help From an Attorney in Starting a Partnership
You may not need an attorney to do the registrations with your state and get the EIN. But, having an attorney help you with the partnership agreement is a definite yes. You may be able to do the first draft and have an attorney look it over. An attorney will help you make sure the agreement complies with your state's laws and will prevent mistakes and missed sections that come back to you later as issues.