Starting a small business is not easy. You might think it makes sense to enter into a partnership. But you should go into it with eyes wide open.
The numbers aren’t encouraging. Estimates of failure rates are as high as 80 percent.
Yet thousands of entrepreneurs enter into partnerships every year.
Let’s look at the pros and cons. For our purposes here, we are mainly talking about a two-person general partnership in a small business. However, some of the issues are universally applicable.
Advantages of Taking on a Small Business Partner
Shared Startup Costs
Pooling your resources lessens the financial burden of launching your venture.
More Borrowing Power
You may not be able to borrow the capital necessary on your own. A partner may tip the scales in your favor.
Shared Debt Liability
You secured your loan. Now you’re on the hook for payments. Many business owners want someone else to share that responsibility.
NOTE: Shared debt liability can be a disadvantage as well.
Possible Tax Benefits
General partnerships, limited partnerships, and limited liability partnerships are pass-through entities. As such, the business doesn’t pay business income taxes. Each partner includes their portion of the income/losses on their personal returns. They pay the individual rate as if it was personal income. Pass-through entities avoid the double taxation that occurs with a S- and C-corporations.
Increased Knowledge and Experience
A broad range of skills might be necessary. Few people are good at everything. Some entrepreneurs don’t believe they can manage a business on their own.
Small Business Partnerships are Easier to Set Up
A partnership can usually be launched more quickly than an S-corporation or C-corporation. For example, you don’t have to create and file articles of incorporation.
Partnerships avoid much of the regulation that a corporation is subject to. That said, make sure you have counsel to guide you on your legal responsibilities.
The Disadvantages of a Business Partnership
Shared Financial and Legal Liability
Shared liability. Think about that. You are liable not only for debts. Each partners is an ‘agent’ of the business. That means each is liable for the actions of the other. What if the business becomes insolvent due solely to the actions of your partner? Your personal assets could be at risk. You could have legal exposure if your partner does something shady.
Difficulty in Defining Roles
Who’s responsible for what? Disagreements about division of duties has doomed many partnerships. When one partner feels like s/he is doing more than the other, resentment sets in. This spreads like a cancer in the relationship. Business partners who were friends in the beginning become enemies. Not a recipe for success.
Small Business Partnerships are Less Secure
Life happens. When a partner dies, retires, or quits for other reasons, the partnership dissolves. An unexpected turn of events can threaten the business’ survival. A corporation is more stable in this respect. The stakeholders must take formal actions to dissolve the entity. Partnerships that grow large and profitable should consider restructuring. At that point, there are many reasons to form a corporation.
Do You Really Need a Partner?
If you are only considering a partner because you can’t start a business on your own, reconsider. There are other ways to get the startup capital. A sole proprietorship also has tax advantages. You can hire people with the expertise you need.
Do you want to be your own boss? A partnership isn’t the way to go.
Do you lack the confidence to do it on your own? This isn’t reason enough to take on a partner.
I’m Already in a Small Business Partnership and it’s Going Bad!
Get out now. If you don’t have a competent acquisitions attorney, get one. Hopefully you started with a contract that anticipated this possibility. (More on that below.)
You may have to buy out your partner. Or set up a royalty schedule. This is complicated and messy. Seek competent counsel and do what it takes.
Starting a Partnership Anyway?
Perhaps you’ve considered everything we’ve discussed. Maybe you trust your partner implicitly and want to proceed. Maybe your shared passion is fueling your confidence.
Protect yourself. Create a legal, highly-detailed partnership agreement. Outline your goals and expectations. Make sure they align. Thoroughly define your roles. Get everything in writing!
Once you’ve set up your business, communicate constantly. Solve little problems before they become big problems. We wish you success!
By Liz Strikwerda