Buying a Business with a Partner
During the depths of the Great Recession, many potential entrepreneurs put their interest on hold to buy and operate their own business. As good economic growth continues to spread, many potential entrepreneurs are now wondering if now the time is right. Because owning a business comes with risk, a good way to manage that risk is with a partner.
Creating a partnership to buy a business or start a franchise
If you are considering buying a business with a partner or buying the rights to a franchise there are lots of items to discuss. Keep in mind the following:
- At a minimum you need 2 to make a partnership. Beware that the more people that join the partnership the harder it becomes as decision making will slow down as all parties will want to know what’s happening, their opinion considered and they want to know any final decision.
- Each partner will expect a share of the profit. The more partners the less there is to share.
- A good strategy at the outset is to understand what each partner brings to the partnership and what that’s worth. Some partners may bring money and little to no interest in knowing day to day operation decisions. Others may want to bring management or specific skills. Others may want a job and compensation over and above their share of the partnership. Yet others may want to work casually in the partnership and be part of all executive decisions. Bear in mind that all these things are often dynamic as not only does the economy change and evolve but so too do people.
- Every partnership should have a buy/sell agreement. This document clearly states how a partner can choose to leave the partnership and how it must be done such as through retirement or if they wish to pursue other interests. Additionally, a partner may leave involuntarily through a health issue, disability or death and if the partners agree, cover this unexpected contingency with insurance.
Here are some other items to consider.
What is a partnership?
A partnership is the simplest and least expensive for two or more business people to operate with legal protections and responsibilities.
By definition, a partnership is a business with more than one owner and no papers have been filed as is required to create a corporation or LLC.
There are two types of partnership – a general partnership and a limited partnership. A general partnership, as it sounds, means all partners are treated equally; which includes upside and downside risks and responsibilities as follows.
What are the risks and responsibilities in a partnership?
In a general partnership, all partners are equal and this includes being personally liable for all business debits and responsibilities be they legal, financial as well as tax. This means, for example, all partners are responsible for business debts including legal judgments. Similarly, if a business owes a creditor such as a supplier, lender, employee or landlord they can be sued to pay that money by filing a legal complaint and if they win, could be allowed to force the sale of a partner’s house or other asset to settle the debt.
The bottom line is that if you do not have 100% trust in the person or people you are considering for a partnership do not even consider this as a viable business option.
Also, there are options to manage the above risk and responsibilities through a Limited Liability Partnership or LLP.
Taxation of a Partnership
A partnership, unlike an LLC or Corporation is not a separate entity from its owner as far as the IRS or in the state where they conduct their business. Like an S Corporation, a Partnership is a “pass-through entity” which means the partnership reports its profit and losses on their individual income tax return or 1040 plus must make quarterly estimated tax payments. While the partnership doesn’t pay taxes, it must report income and expenses on IRS form 1065 which then sets out each partners share.
How to create a partnership
Starting a partnership is as simple as a verbal agreement. Starting a good partnership comes with many conversations around what, where, how, when and especially why. It’s also a good idea to discuss with others you know that are in a partnership to understand the pros and cons from their perspective as well as your attorney and accountant; especially if you move forward and set things up.
Other items to consider include any state and local tax requirements, a Federal EIN or Employment Identification Number, if appropriate, permits and licenses. In California you are also required to file at the county level, a Fictitious Business Name.
It’s not mandatory but I’m a great believer in a Business plan so building a document like this and having it reviewed by an experienced third party can be invaluable and make learning curves much quicker.
How to end a partnership
As we said above, it’s very easy to create a partnership and equally, if one partner chooses to leave the company or partnership it generally dissolves. If the partnership is to dissolve, the partners must complete their current business obligations, pay off all debts and divide any property that has been built be it profits or soft or hard assets.
To prevent the company and partnership from needing to dissolve, as was mentioned above, anticipate this scenario when the partnership first comes together by creating a buy-sell agreement or buyout agreement which can be part of a written partnership agreement. If you want to prevent this kind of ending for your business, you should create a buy-sell agreement, or buyout agreement, which can be included as part of your partnership agreement.
A partnership is only the best option if all parties understand the risks and responsibilities. It’s not just a matter of understanding when you start out in business, it’s equally important as you continue be it in year one or year twenty one. People evolve and change. About 50% of the population get a divorce because of change and either one party likes the change while the other party does not.
Before you make that final decision to come together in a partnership, talk to an attorney that specializes in business law to get their legal advice and therefore hopefully avoid needing an attorney later on when you realize that entering a partnership was not the best decision you made.
For more immediate help with buying a business you are welcome to send an email to Andrew Rogerson or give me a call on 916 570-2674.