SelfInformed

May 2015


Benefits, Risks And Insights On Partnering In Business

Tuesday, May 19, 2015

Partnering is a topic that arises for many business owners. If you are a micro business owner, small business owner or other entrepreneur, partnering can be an effective way to access and tap resources that do not currently exist within your business. Partnering can also be a means for growing a business. In addition, you may opt to partner with one or more founders to start a new business. Although business partners can provide numerous benefits, it is very important to be aware of and to understand the risks and pitfalls associated with partnerships to ensure you choose the best options
to strengthen and grow your business.

As a business owner, you may wonder what the challenges associated with partnering are and how to mitigate the issues that arise. In addition, you may question whether partnering makes sense and, if so, when? This article will help you determine the answer most suitable to your situation and needs.

Definition

According to the IRS, a partnership is “a relationship between two or more persons who join to carry on a trade or business, with each person contributing money, property labor or skill and each expecting
to share in the profits and losses of the business whether or not a formal partnership agreement
was made.” The Law Dictionary defines a business partner as “a commercial entity with which another commercial entity has some form of alliance.”

There are four types of partnerships.

General partnership: When you form and operate a business with another individual without organizing as a separate legal entity (i.e., a corporation or limited liability company), federal and state laws automatically classify your business as a general partnership. For example, you bring someone on board to handle administrative duties and agree to partner to avoid paying her upfront. You just formed a general partnership.

Joint venture: A joint venture results when two or more parties form a separate business but otherwise remain distinctly separate entities.

Limited partnership: This is a type of general partnership that provides limited partners with individual protection against personal liability. The general partner still has full liability.

Special purpose: This is a contractual relationship formed for a specific purpose such as the co-marketing arrangements that many technology companies enter into or the supplier relationships that often exist between distribution companies and retailers.

All partnerships can also be transactional – focused on a specific deal or transaction - or strategic – utilized to grow market share or to accomplish particular ongoing objectives.

Benefits

One key benefit that partnerships provide is access to the skills or capital you do not currently have. Through partnering, you can provide a more well-rounded knowledge base and skill set to your business and your customers, thus enabling you to better serve your target market’s needs. By combining financial resources, you can build a stronger business faster than you could alone. Partnering also enables you to reduce risks through sharing or through enhanced knowledge.

Additional benefits of partnering include:

- Access to new markets

- Introduction to new or expensive technology

- Navigate different paths to your existing market

- Creation of a new value proposition

- Offer new products or services through combining your respective products or services

- Generation of new or greater financial opportunities.

Risks

Although partnering can provide your business with many benefits, you must be aware of the risks and how to mitigate them. Operating as a general partnership is one huge risk.

Key general partnership risk: Joint and several liability

Explanation: You and your partner are jointly responsible for any debt or liability that your business or either partner incurs. In addition, each partner can be held responsible for all the liabilities incurred.

Example: Your partner is at fault in an automotive accident. You own a house and other investments but your partner owns nothing but his car. In addition, your partner carries only the minimum liability insurance on his vehicle. The injured party’s attorney subsequently names both of you in the lawsuit but focuses his efforts on pursuing your assets.

Another significant risk is a break-up. As with marriages, many partnerships do not last. Poor communication, changing priorities, and shifting objectives all contribute to break-ups. If you did not work out an exit strategy in advance, then the “divorce” could be serious. If you have a special purpose partnership in which you only periodically engage, a break-up will typically be relatively minor. However, if you have worked together closely for a few years, the break-up could be emotionally and financially devastating.

Additional risks include the following:

Different leadership styles. If you are a democratic leader (shared opinions and decision-making) but your business partner is autocratic (taking no account of other people's wishes or opinions), your personalities could clash. In addition, the divergent leadership styles could send conflicting messages to employees or independent contractors.

Different financial goals. If you want an income of $200,000 per year from the business and your partner wants $50,000, you may argue over money (profits, cash flow, or revenue) often.

Shifting life goals (i.e., priorities)

Changing time commitments

Poorly defined leadership roles.

Frequently Asked Questions

What is a partnership agreement or buy/sell agreement?

This agreement is the document that governs your formal partnership. Excluding specific purpose partnerships, all partnerships should have one. This agreement clearly delineates what happens if you decide to disband, receive an offer to buy your company, become ill or disabled, and other similar scenarios. Also specify roles and responsibilities and who has the final say in each business function. Include a clear exit strategy.

By fully completing this process, you will generate a legal document you can refer to when you have strong disagreements

How do I avoid a messy break-up?

Discuss in advance the scenarios that could lead to a break-up and determine how, if these occur, you will dissolve the partnership.

Meet several times over a week or more to ensure you include everything in your buy/sell agreement. The more comprehensive the partnership, the more important this step is.

How do I protect myself in a general partnership?

First, avoid legally operating as a general partnership. If you and another individual are jointly starting a business or building a business by merging your separate firms, consider structuring your business as a corporation or LLC. If you have multiple partners, consider a limited partnership.

Second, create a clear and comprehensive buy / sell
or partnership agreement.

How do I protect myself in marketing, vendor, or other partnerships?

A contract is only as good as the thought that went into it. Therefore, before engaging an attorney to document your marketing or other partnership in a contract:

Discuss and clearly define the partnership’s goals and objectives, time line, each partner’s responsibilities, and the agreement’s duration. Also include a communication schedule you can adhere to. Finally, be sure to include dissolution and renewal clauses to ensure the smoothest possible exit or an easy renewal.

What are the IRS tax ramifications of a partnership?

Partnerships are taxed as pass-through entities -
partnerships do not pay taxes on their income. Instead, the income (or losses) flow through the partnership and are paid by each separate partner. Partnerships must file Form 1065. LLCs that elect
to be treated as partnerships for tax purposes must file Form 1065, U.S. Return of Partnership Income.

Should my partnership be 50 – 50?

For general partnerships, the answer is usually no. It is better to have one person as majority partner and have that partner make executive decisions when disagreements cannot be resolved.

However, if you fully complete a buy/sell agreement, a 50-50 partnership may work.

Do I really need a partner?

If you need to fill vital gaps in the business - for example, a strong business network, critical business skills you lack, or funding to grow the business, you likely do need a partner.

If you want a partner to perform duties you dislike, bounce ideas off of, hold you accountable or reduce your fear of flying solo, you do not need a partner. Instead, you should hire someone, get a coach, or build an advisory board.

I have a family business and my sister (or other family member) wants to get involved.

Because failed partnerships within a family business can seriously damage or destroy personal relationships, it is vital that you spend even more time creating your partnership agreement. If you have divergent personal or financial goals, different management styles, or different work ethics, these will undermine your working relationship and potentially become fodder for personal attacks. By being very clear about who you are, what you want, and why you want it, you can determine if you should partner and, if so, how you should structure your intra-family partnership.

References

Eastern Illinois University: An Overview of Strategic Alliances

University of Central Arkansas: Strategic Alliances: Are They Relational By Definition

IRS: Partnership Returns 2012

An Expanded Model of Business-to-Business Partnership Formation and Success

Department of Energy: Structuring a Partnership for Success (Cummins MerCruiser partnership)

Harvard Business Review: Simple Rules for Making Alliances Work

SBA: Partnership  

BPI Network: Grow from the Right Intro

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