The easiest way to start a business with someone else is to establish a general partnership. You don’t have to file paperwork with the state to set one up, your business income will pass through to your personal tax return, and you won’t have ongoing recordkeeping or reporting requirements.
Sounds great, right? But general partnerships also have a big downside – they don’t offer you any protection from liability. If you’re starting a business with a partner, it’s important to understand the advantages and disadvantages of a partnership structure and decide whether you want to move ahead with a partnership or set up a different type of business entity.
Pros and Cons of a Partnership
It is easy to form a partnership: if you and a partner start a business, you’ve created a general partnership. You don’t need to file any formation paperwork with the state when forming a partnership.
General partnerships don’t pay partnership tax: the partnership files an informational tax return, and its profits and losses pass though to the partners, who report those numbers and pay taxes on them as part of their personal tax returns.
As an alternative to a general partnership, business partners can set up a limited liability company or corporation. Unlike general partnerships, LLCs and corporations provide their owners with limited personal liability for business obligations.
You may also form a limited partnership that has some general partners who are liable for all business obligations and some limited partners whose liability is limited to their investment in the company. Some states also allow for a limited liability partnership, where all of the partners enjoy some degree of liability protection.
Advantages of a general partnership business include:
- It is easy and inexpensive to set up and maintain.
- It is flexible: you can manage it and split profits and losses in any way you choose.
- You’ll receive pass-through taxation and avoid corporate income tax.
However, general partnerships also have some significant disadvantages:
- Each partner in a general partnership is fully liable for the entire amount of the business’s financial obligations. In contrast, the liability of LLC and corporation owners is limited to the amount they have invested in the company.
- You risk losing all your personal assets if the business is sued or if one of your partners or employees is sued for a business-related incident. This liability risk is the main reason many business attorneys advise against general partnerships.
- Corporations can deduct certain employee benefits on their tax returns, but this may not be true for your general partnership.
How to Start a Business with a Partner
Step 1: Do You Need a Partner?
While a partner can contribute valuable skills and cash to your business, you also must split profits with a partner, and you must agree on business decisions. Sometimes it’s better to hire an employee than to take on a partner.
Some of the best partnerships are the ones where each partner contributes a crucial, but complimentary skill. For example, one partner may understand all the technical aspects of product development while the other excels at sales and marketing. Business partners should have compatible work styles, similar values and similar goals for the business. Spend some time exploring these issues before you commit to a business partnership.
Step 2: Choosing a Name
The name you choose for your partnership might reflect the names of the partners or it might say something about the kind of business you’re in. It’s a personal choice, but there are a couple of things to consider:
- Don’t choose a name that is already being used by another business in your state. You may be infringing the other business’s trademark, and if you later decide to form a corporation or LLC, you can’t register a name that another business is already using.
- For marketing purposes, you may want to choose a name for which a matching domain name is available.
Step 3: Creating a Partnership Agreement
In the early days of a business, partners usually get along splendidly. So it can be easy to neglect the most basic document that you need to protect yourself: a partnership agreement.
A partnership agreement can specify everything from the assets you have contributed to the business to the way you will split profits to the way you will handle things if there is a dispute or one of you decides to leave the business. It’s far easier and cheaper to agree on these things at the outset, when everyone is getting along, than to try to resolve them after there’s a disagreement
Step 4: Registering with the State
Most states require you to register a fictitious business name, also known as a “doing business as” name or “DBA” if you are going to be doing business in a name other than your own name. To register, you will need to fill out a form and submit it, along with a filing fee, to your state agency in charge of business filings.
Step 5: Final Steps for Starting a Business
Your partnership will also need a federal employer identification number (EIN) from the Internal Revenue Service. Once you have your EIN, you can open a bank account in your partnership’s name.
Depending on the type of business you’re in, you may need to register with other state and local agencies or obtain licenses or permits. For example, you must register with your state’s revenue department if you are selling goods or services that are subject to sales tax.
Finally, contact a business insurance agent and get adequate insurance for your partnership business. Insurance is important for all small businesses, but it is especially crucial for a general partnership where all of your personal assets are at risk.
It’s easy to start a partnership, but be sure to take steps to protect yourself. Choose your business partners carefully, and make sure you have a partnership agreement and adequate business insurance.
LegalZoom makes it easy to get a limited partnership agreement or limited liability partnership agreement. Just answer a few simple questions in our online questionnaire and we’ll check your answers for completeness and consistency, then send you the final document.