When someone starts a new business, one of the first decisions to make is whether or not to form a sole proprietorship or partnership. Partnerships alter the legal structure of the business, taxes and relationships in ways you must consider before you simply assume the best solution is dividing ownership of the business.
There are pros and cons of bringing in others as partners instead of hiring them as employees or receiving loans instead of giving away equity.
Paperwork
It is easier to create a general partnership than form a corporation. The biggest risk this creates is personal liability. A corporation is a separate legal entity that has to have its own financial accounts and takes on the financial and legal liabilities of the company. If the company goes bankrupt, that does not affect the employees beyond loss of their jobs. When a company is sued, the employees are not personally liable. In a partnership, the partners are all liable for the fines the company receives and debts it owes.
There are matters you need to address before you set up the partnership, such as how the death, disability, departure or divorce of one partner will be handled. If you don’t spell this out in writing when the partnership is formed, you risk having to liquidate the business or go into debt to buy out the other partner when their spouse leaves and demands half of everything, including half of their stake in the partnership.
Income
Partnerships split both the income that comes in, after expenses, and the losses. If you want to start a business and go into a partnership, you will likely have to split the income from the business for years. Conversely, if you start the business as a sole proprietor and hire help as employees, contractors or consultants, you will retain full ownership of the business. You’ll have to pay others out of the business’ income today, but you won’t have to split the business’ income later if the business does well.
On the flipside, you may be able to attract talent with the offer of partnership or an equity stake to build the business though it currently has no income.
Taxes
One of the benefits of a general partnership is the tax benefit. Profits and losses pass down to the individual partners. In general, the partnership pays taxes but doesn’t pay taxes on it as a business. Partners file tax returns based on their individual shares of the company profits and losses. This financial model can simplify taxes and bookkeeping compared to paying several different employees and their tax withholding. However, business partners may have trouble applying for a mortgage when the business losses make it appear like they have no reliable income.
Decision Making
Partnerships divide ownership of the company between two or more people, and your partnership needs to decide how decisions will be made. One person may provide the technical or professional expertise the partnership offers, while the other runs the back office or drums up business.
Tai Lopez stated as part of an interview with Fortune that the best partnerships involve people with complementary skills. In this piece, Tai Lopez compares partnerships to marriages, where the best partner is stress relieving and allows you to not carry the weight of the world on your shoulders. In the worst case scenario, the breakup of a business is as bad as divorce. Conflicts over how to run the business can cripple it or even kill it, since an inability to make timely decisions or contradictory actions by different partners will undermine the venture’s success.
As the number of partners increases, the ability of the business to make decisions is hindered by any requirement to have consensus of the partners. Problems arise when one or more partners are unhappy with how the business is run, and unlike employees, they have a say in the matter due to their equity stake. In this regard, it is better to hire your first employees after founding the business instead of giving everyone you bring in a small share of the equity.
Conclusion
Partnerships can provide you with a way to attract quality, key people to run and grow your business when you cannot afford to hire them. Partnerships require you to share decision making with your partners, and conflicts over decision making can cripple or kill your business. The paperwork to set up the partnership and ongoing tax forms are simpler for partnerships, but partnerships leave partners legally and financially liable.
