Going into business with a partner, adding one after you’ve started your company, or taking on an investor all have advantages and disadvantages. Some are financial, some legal, some psychological and some management-based. Understanding that a business partnership can be like a marriage will help you take steps to analyze if this decision is right for you and learn how to structure a partnership to avoid potential pitfalls.
Types of Partnerships
When you partner with one or more people in your business, you have different options for structuring your business partner agreement.
If you’re willing to share the management decisions, responsibilities and liabilities of the business, a general partnership might be your best option. This type of partnership gives you more say in how the company is run, but also opens all partners to the most legal liability.
If you want to name one head honcho (including yourself), with other partners taking subordinate roles, you can form a limited partnership. This limits the liability each partner has to his or her stake in the business, except for the main partner. This general partner calls the shots, which is why the other partners have reduced liability. With this type of partnerships, you can lose some or all of your personal assets if you have to pay off the business’s debts.
•Limited Liability Partnership
An LLP arrangement protects all partners from personal liability and does not require one general partner to take full responsibility for the business. You can lose your business assets, but your personal assets are safe. You also can’t be sued for the actions of a partner.
Other common terms for partnerships you might hear include:
Silent Partner – someone who invests money, has no say in how the business is run, gets a specific payback, or owns a percent of the profits and/or owns a part of the business. This partner usually wants an LLP situation (no liability).
Investor – another name for a silent partner. Investors can be long- or short-term partners who either take an agreed-upon return on their investment or an ongoing piece of the business. Unlike a lender, an investor owns part of your business or profits.
Equity Partner – someone who owns a percentage of the business. A non-equity partner might simply get a percentage of the operating profits and/or a salary, but not a piece of the eventual sale price of the business.
Secured lender – not a true partner, but someone who lends you money in exchange for you putting up the business or specific assets as collateral. This type of lender can include a bank, commercial lender or other person who earns interest on the loan.
Unsecured creditor – this type of lender gets no collateral, but often a higher return on a loan or line of credit.
Advisor – this person provides expert information to help your run the business and may or may not put any capital into the company. Unlike a silent partner, this person gives you advice to run the business. An advisor will probably want no legal liability.
Pros of Partnerships
Taking on a partner can provide many benefits, including reducing the fear and anxiety that often accompany a new business venture. A partner lets you bounce ideas off him, gives you honest feedback, can reduce your workload and can catch mistakes you make. Partnerships allow different stakeholders to use their expertise to run different areas of the business. With a restaurant partnership, for example, one partner might manage the kitchen; another might handle the dining room and staff, while another partner oversees the marketing and finances.
Other benefits of partnerships include:
•Access to more capital
•Access to more expertise
•Access to contacts
•Better quality control
Cons of Partnerships
If you don’t properly create your partnership, you might face “too many cooks in the kitchen.” Partnerships can also make you responsible for the fraudulent activities of one or more of your partners. If your agreement doesn’t prohibit it, your partner might sell her share to someone else you don’t want to work with, or leave her share to an heir you don’t want involved in your business.
Partnerships also cost you money. If your main reason for seeking a partner is because you need operating capital, read the Smarty Cents article on finding capital for funding a small business, which might help you eliminate the need for a partner.
Another problem with partnerships is that one or more partners might want to quit the business. While they can’t force you to close the business, they can force you to buy them out if you want to keep the business running. If you don’t have the capital, you might have to shut your doors.
Setting Up Your Agreement
It’s best to use an attorney to draw up a legal partnership rather than relying on a handshake or verbal agreement even if you’re partnering with a family member or close friend. Just the act of drafting a contract can reveal management, profit-sharing and dissolution issues you might not have considered on your own. Things to consider when drafting a partnership agreement include:
Who is in charge?
How are profits split?
How can the business be dissolved?
Can partners buy each other out?
Can partners sell or will their ownership stake to anyone they want?
What are each partner’s responsibilities?
What are each partner’s liabilities?
What is non-performance and what happens when a partner doesn’t hold up his end of the agreement?
Sam Ashe-Edmunds has been a small-business consultant and owner for more than 25 years. He has written for a wide variety of magazines, newspapers and websites, including Entrepreneur, The Chicago Tribune, Chron Small Business, AZ Central Your Business, TheNest, Zacks, Motley Fool, Synonym Money, GlobalPost and Opposing Views.