Partners can be the best thing that ever happened to your business, or the worst if entered into improperly. Thus, don’t be afraid of a ‘partnership’, but just be committed to documenting it properly and considering all of the issues.
The Partnership Agreement and setting up the proper entity/structure for the partnership is the single most important step in the partnership process, maybe even more important than analyzing the merits of the project within the partnership itself. You could have the most potentially successful money-making idea in the world, but if the foundation for the partnership is faulty, the business will ultimately fail.
Here is a checklist of considerations when entering into a partnership that should be helpful:
Contributions of Capital. What in time, money and assets is each partner contributing to the partnership? This includes the initial contributions as well as additional contributions that may be necessary to continue operating the business in the future.
Rights to Distributions, Profits, and Losses. Any right of a member to receive discretionary or mandatory distributions, which includes a return of all or any of the members’ contributions, needs to be clearly and specifically set forth in the Partnership Agreement. Moreover, both limited and general partners should be concerned as to whether or not, and how, profits and losses will be allocated by the partnership. There is a difference between distributions of money and allocations of profits and losses on the tax return.
Percentage of Ownership. It is absolutely critical to consider your ownership percentage in relationship to the other partners. Control of the business is what will ultimately determine your personal return on your investment.
Dissolution. The Partnership Agreement should indicate the events upon the happening of which the partnership is to be dissolved and its affairs wound up. An exit strategy for the business as a whole, as well as the individual comings and goings of partners, is often overlooked. It is easy to get things started.
The form of Doing Business. Choosing the right type of entity is critical when entering into a partnership. For example, an S-corporation may be extremely beneficial to the partners to save on self-employment tax. On the other hand, a Limited Liability Company could be more flexible and allow for special allocations of profit, loss and voting rights. From a liability perspective, it cannot be emphasized enough that setting up the proper entity is extremely important to prevent unnecessary exposure and liability to the various partners.
Security. If you are a silent partner or even a participating partner, please make sure there are checks and balances in place for the management of the cash and assets in the business. Make sure that your partner cannot run with the money and if he or she does, there is protection in the partnership agreement for acts of fraud and the requisite fiduciary requirements.
Representation. Have a competent and honest attorney either represent the company, or have each partner obtain his or her own attorney to review the partnership documents and address all of the above issues, as well as the individual and specific needs of you and your partner’s particular situation.
Authorization to Managers/Officers. Have a very clear list and understanding of what the managers or officers of the business are authorized to do on behalf of the company. Furthermore, there should be a description of each partner’s responsibilities and duties so each partner knows what to expect from each other.
The above is certainly not a comprehensive list of all of the issues you should consider when forming a partnership, however, I feel strongly that it is a ‘good start’. Please make sure that you are sitting down with your partner or partners discussing the best case AND the worst case scenarios. Trust me when I say, you will face both types of scenarios.
Mark J. Kohler is a CPA, Attorney, Radio Show host and author of the new book “The Tax and Legal Playbook- Game Changing Solutions For Your Small Business Questions” and “What Your CPA Isn’t Telling You- Life Changing Tax Strategies”. He is also a partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP and the accounting firm K&E CPAs, LLP. For more information visit him at www.markjkohler.com.