Are you interested in starting a business or growing your existing business? Bringing on a business partner can offer several advantages. These include expertise in different business areas, strategic connections and more capital.
But select the wrong partner and you could be setting yourself up for years of personality conflicts and lawsuits. And ultimately, the end of your business.
Before you even think of approaching a potential business partner, consider whether you really need one. Then, get clear on the type of person who will be a good match for your own skills, values and goals. It’s much harder to undo a business partnership than it is to create one. Here’s what you should know before taking on a business partner.
What does a business partnership entail?
A partnership is a relationship between two or more people who carry on a business together. For tax purposes, partnerships are known as pass-through businesses. This means the partnership doesn’t pay taxes. Rather, partnership income or losses are passed through to owners. The owners then pay taxes on their share of profits on their individual tax returns.
Partnerships are the second most common type of pass-through business in the U.S., just behind sole proprietorships. That popularity stems, at least in part, from the ease of creating a partnership.
According to SCORE, a nationwide network of volunteer business mentors, partnerships aren’t a legal business entity. In some cases, they don’t have to be registered with the state. This is unlike corporations and limited liability companies (LLCs) do. Essentially, if you go into business with another person without incorporating, you’re in a partnership by default.
Despite that informality, forming a business partnership isn’t a decision to take lightly. Even if you don’t have a formal agreement, you have basic legal responsibilities to other members of the partnership. Such as:
- Sharing planning and decision-making rights
- Maintaining appropriate financial records
- Sharing business profits and losses based on each partner’s investment
- Compensating partners for expenses they pay on behalf of the business
- Getting your partner’s consent before bringing on extra partners
- Returning your partner’s original capital contribution should they to leave the partnership
How to identify a solid business partner
Choosing a business partner is like choosing a spouse. You’re trusting this person with your financial investment and your future. That’s why it’s so important to choose your partner wisely.
So what kind of criteria should you look for? Consider these six questions.
What are your goals?
What happens if you want to grow your business internationally, but your partner wants to keep it small and local? Not being on the same page about target market, investments and long-term strategy can lead to a lot of unnecessary conflicts. You and your partner should have similar goals for the future of the business.
How are their finances?
Unless you already have an open relationship with your potential partner, you likely won’t know much oft their financial history. Going into business with someone with poor credit or shady financial dealings can get you into trouble. Consider having a potential partner submit to a background check and credit check.
Do they have complementary skills?
People tend to want to do business with other people who have similar temperaments, skill sets and backgrounds. While this can be a good basis for friendship, it’s not always the best for a business partnership.
Look for a partner who is better than you at certain things. For example, if you’re the whiz with numbers, you might need someone who is a great communicator or leader. But, if your focus is big, long-term strategies, you might need a partner with excellent attention to detail. Bringing complementary skills together makes your partnership greater than the sum of its parts.
Do you have a personal relationship?
Partnering with your spouse, sibling or best friend might seem like a great idea to start. But proceed with caution when forming a business with someone with whom you already have a personal relationship.
According to a PWC survey, 23% of owners and executives in a family-owned business say they’ve never had a disagreement with their family members. Meanwhile, disagreements are a regular occurrence for 7% of family-owned businesses.
Close relationships can suffer if the business fails due to conflict. Which many do — data shows 20% fail in the first year alone. This isn’t to say that you should never do business with friends and family. But if you do, make sure you have a written partnership agreement. Outline responsibilities and how you’ll resolve potential conflicts.
Have you considered a trial run?
Until you’re actually in business with someone, it can be tough to understand their work style or how they’ll react in difficult situations. If you don’t have any experience working with your potential partner, consider doing a trial run. You could work on a project together or hire them as a consultant.
This allows you to see how well they communicate. See if they pull their weight and work through challenges. If it goes well, you can formalize your business partnership. If it doesn’t go well, you have a chance to walk away sooner rather than later.
Do you have a written partnership agreement?
No matter whom you choose as your business partner, you need a written partnership agreement. This agreement spells out the rules for how the partners will manage their business. It includes responsibilities, investments, profits and losses, company management and conflict resolution. It can also address what happens when one partner wants to sell or leave the business.
Don’t skip the formal agreement because you’re starting a business with family or afraid of hurting someone’s feelings. A partnership agreement is always important. But it can be even more crucial when you’re starting a business with a friend or family member. Plus, a well-thought-out agreement can help lessen misunderstandings and preserve your relationship.
Each state has its own laws governing formal business partnerships. So it’s a good idea to work with an attorney who specializes in contract law. They can help you create a custom (and legally enforceable) partnership agreement.