WHEN CONSIDERING A BUSINESS PARTNERSHIP, DETERMINE YOUR ASSETS THAT WILL BE AT RISK
Partnership is an association of two or more persons to carry on as coworkers of a business for profit. The essential characteristics of this business form, then, are the collaboration of two or more owners, the conduct of business for profit (a nonprofit cannot be designated as partnership), and the sharing of profits, losses, and assets by the joint owners.
A partnership is not a corporate or separate entity; rather it is viewed as an extension of its owners for legal and tax purposes, although a partnership may own property as a legal entity. While a partnership may be founded on a simple agreement, even a handshake between owners, a well-crafted and carefully worked partnership agreement is the best way to begin the business. In the absence of such agreement, a set of laws pertaining to partnerships that has been adopted, govern the business. Therefore, unanimous consent of the partners is required for all major actions undertaken. Be advised, though, that any obligation made by one partner is legally binding on all partners, whether or not they have been informed.
- Collaboration: as compared to sole proprietorship, which is essentially the same business form but with only one owner, a partnership offers the advantage of allowing the owners to draw on the resources and expertise of the copartners. Running a business on your own, while simpler, can also be a constant struggle. But with partners to share the responsibilities and lighten the workload, members of a partnership often find that they have more time for the other activities of their lives.
- Tax advantages: The profits of a partnership pass through to its owners, who report their share on their individual share returns. Therefore, the profits are only taxed once (at the personal level of its owners) rather than twice, as is the case with corporations, which are taxed at the corporate level and then again at the personal level when dividends are distributed to the shareholders. The benefits of a single taxation can also be secured by forming an S corporation (although some ownership restrictions apply) or by forming a limited liability company.
- Simple operating structure: A partnership as opposed to a corporation , is fairly simple to establish and run. No forms need to be filed or formal agreement drafted (although it is advisable to writ a partnership agreement in the event of future disagreements) The most that is ever required is perhaps filing a partnership certificate with a state office in order to register the business’s name and securing a business license. As a result, the annual filing fees for corporations, which can sometimes be very expensive, are avoided when forming a partnership.
- Flexibility: Because the owners of a partnership are usually its managers, especially in the case of a small business, the company is fairly easy to manage, and decisions can be made quickly without a lot of bureaucracy. This is not the case with corporations, which must have shareholders, directors, and officers, all of whom have some degree of responsibility for making major decisions.
- Uniform laws: One of the drawbacks of owning a corporation or limited liability company is that the laws governing those business entities vary from state to state and are changing all the time. In contrast, the Uniform Partnership Act provides a consistent set of laws about forming and running partnerships that make it easy for small business owners to know the laws that affect them.
- Acquisition of capital: Partnerships generally have an easier time acquiring capital than corporation because partners, who apply for loans as individuals, can usually get loans on better terms. This is because partners guarantee loans with their personal assets as well as those of the business.
Banks also perceive partners to be less of a risk than corporations, which are only required to pledge the business’s assets. In addition, by forming a limited partnership, the business can attract investors (who will not be actively involved in its management and who will enjoy limited liability) without having to form a corporation and sell stock.
Drawbacks of forming a partnership
- Conflict with partners: while collaborating with partners can be a great advantage to a small business owner, having to actually run a business from day to day with one or more partners can be a nightmare. First of all, you have to give up absolute control of the business and learn to compromise. And when big decisions have to be made, such as whether and how to expand the business, partners often disagree on the best course and are left with a potentially explosive situation. The best way to deal with such predicaments is to anticipate them by drawing up a partnership agreement that details how such disagreements will be dealt with.
- Authority of partners: when one party signs a contract is legally bound to fulfill it. For example, if Adebayo orders N20million of production equipment, it is as if his partners, Hauwa and Emeka, had also placed the order. And if their business cannot afford to pay the bill, then the personal assets of Hauwa and Emeka are on the line as well as those of Adebayo. And this is true whether the other partners are aware of the contract or not. Even if a clause in the partnership agreement dictates that each partner must inform the other partners before any such deals are made, all of the partners are still responsible if the other party in the contract (the equipment company) was not aware of such a stipulation in the partnership agreement. The only recourse the other partners have is to sue.
- Unlimited liability: As the previous example illustrated, the personal assets of the partnership’s members are vulnerable because there is no separation between the owners and the business. The primary reason many businesses choose to incorporate or form limited liability companies is to protect the owners from the unlimited liability that is the main drawback of partnerships or sole proprietorships.
If an employee or customer is injured and decides to sue, or if the business runs up excessive debts, then the partners are personally responsible and in danger of losing all that they own. Therefore, if considering a partnership, determine your assets that will be at risk. If you possess substantial personal assets that you will not invest in the company and do not want to put in jeopardy, a corporation or limited liability company may be a better choice.
But if you are investing most of what own in the business, then you don’t stand to lose any more than if you incorporated. Then if your business is successful, and you find at a later date that you now possess extensive personal assets that you would like to protect, you can consider changing the legal status of your business to secure limited liability.
- Vulnerability to death or departure: Unlike corporations which exist perpetually, regardless of ownership, general partnerships dissolve if one of the partners dies, retires, or withdraws. (In limited partnerships, the death or withdrawal of the limited partner does not affect the stability of the business). Even though this is the law governing partnerships, the partnership agreement can contain provisions to continue the business. For example, a provision can be made allowing a buyout of a partner’s share if he or she wants to withdraw or if the partner dies.
- Limitation on transfer of ownership: Unlike corporations, which exist independently of their owners, the existence of a partnership is dependent upon the owners. Therefore, the Uniform Partnership Act stipulates that the ownership may not be transferred without the consent of all the partners. (Once again, a limited partner is an exception: his or her interest in the company may be sold at will.)
Choosing a Partner
Because of the need for compromise and the dynamics of shared authority that come along with sharing a business, partners can be very difficult to maintain and run effectively. Therefore, the single most important decision a business owner has to make when forming a partnership is the choice of a partner.
Be warned that you should only take on a partner if you absolutely need that person’s money or expertise. As an alternative, you should try to get money as a loan, or hire the person as a consultant to get the expertise. But if you decide that forming a partnership is the best choice, consider the following when selecting a partner (anyone can become a partner except minors and corporations.) .
- How much does your partner own in personal assets? If you own much more than your partner, then creditors will come after you in the event of extensive debts.
- Do you possess compatible personality types?
- How do each deal with stress?
- How do you make decisions? Does your prospective partner tend to talk things through with others or make impulsive decisions?
- What role do each of you tend to take in the business? Are these roles compatible? Do you both hope to be in charge of the accounts or dealing with vendors, for example? Or can you split up the duties in a way that satisfies both of you?
- How much time will your partner contribute to the enterprise?
- Can you count on your partner to show up to work on time? Or you will be expected to cover for him?
- Is your prospective partner a hard worker, or he or she routinely leaves tasks for you to complete?
GOALS FOR THE BUSINESS
- How does each of you envision the future of the business? Do you hope to build up a solid business and then expand to other locations? Does your partner share that vision or does he or she only hope to be able to make a decent living out of one business with fewer responsibilities than would be required if running a chain of stores?
FORMING A PARTNERSHIP
Reserving a Name
The first step in creating a partnership is reserving a name. The name of the partnership must not resemble the name of any other corporation, limited liability company, partnership, or sole proprietorship that is registered with the state Corporate Affairs Commission (CAC).
The Partnership Agreement
A partnership can be formed in essentially two ways: by verbal or written agreement. A partnership that is formed at will, or verbally, can also be dissolved at will. In the absence of a formal agreement, state laws will govern the business. These laws specify that without an agreement, all partners share equally in the profits and losses of the partnership and that the partners are not entitled to compensations for services. If you like to structure your partnership differently, you will need to write a partnership agreement.
It may be advisable to consult a lawyer before drafting the agreement, but you should at least research the issue on your own. A thorough partnership agreement should generally cover the following areas:
- Name and address
- Duration of partnership: You can specify a finite date on which all business will terminate or you can include a general clause that explains the partnership will exist until all partners decide to dissolve it or a partner dies.
- Purpose of business
- Partners’ contributions: These may be in cash, property or services. Be sure to determine the value of all noncash contributions.
- Partners’ compensation: Determine how profits will be split up and how often. Also decide if any of the partners will receive a salary.
- Management authority: Will partners be able to make some decisions on their own? Which decisions will require the unanimous consent of all partners?
- Work hours and vacation.
- Kinds of outside business activities that will be allowed for partners.
- Partner withdrawal: Decide how the death, retirement, withdrawal, disability, or death of a partner will be handled through a buy/sell agreement. Also determine whether or not a partner who has simply withdrawn will be allowed to operate a competing business.
- Disposition of the partner’s name if a partner leaves.
- How to handle disputes: decide whether or not mediation will be provided for in the cause of disputes that cannot be resolved amongst the partners. This is a way to avoid costly litigation.
Rights and Responsibilities of Partners
The Uniform Partnership Act defines the basic rights and responsibilities of partners. Some of these can be changed by the partnership agreement, except, as a general rule, those laws that govern the partners’ relationship with third parties. In the absence of a written agreement, then, the following rights and responsibilities apply:
- All partners have an equal share in the profits of the partnership and are equally responsible for its losses.
- Any partner who makes a payment for the partnership beyond its capital, or makes a loan to the partnership, is entitled to receive interest on that money.
- All partners have equal property rights for the property held in the partnership’s name. This means that the use of the property is equally available to all partners for the purpose of the partnership’s business.
- All partners have an equal interest in the partnership, or share of its profits and assets.
- All partners have an equal right in the management and conduct of the business.
- All partners have a right to access the books and records of the partnership’s account and activities at all times. (This does not apply to limited partners).
- Partners must return and turn over to the partnership any income they have derived from the use of the partnership’s property.
- Partners are not allowed to conduct business that competes with the partnership.
- Each partner is responsible for contributing his or her full time and energy to the success of the partnership.
- Any property that a partner acquires with the intention of its being the partnership’s property must be turned over to the partnership.
- Any disputes shall be decided by a majority vote.
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