Forming a Partnership

Partnership: It Takes Two or More to Tango

Everyone knows people who wouldn’t dream of going to the movies by themselves. Or out to dinner. Or to a party. Or to the beach. Or you name it.

The advantages of a partnership are clear: shared work, shared financial burdens, and shared risk. Partners may also bring talents and expertise into the business that sole proprietors may not have alone. All good stuff.

There are disadvantages, too. Sharing responsibilities, control over the company, and profits and losses can be more complicated and difficult than going it alone.

Here are some major factors to consider when deciding whether a general partnership is the best way to structure your business.

  • Complexity and Expense - While it is more complex to organize than a sole proprietorship, a general partnership still involves fewer formalities and legal restrictions than other types of business organizations. Basic elements of are established by state law, but most issues are decided by a written agreement between partners.

  • Owner Liability - As a partner, you may be personally liable for up to the full amount of the debts of the business, even if the debts exceed the amount of your investment. Partners with greater personal assets risk losing more than those with few assets.

  • Distribution of Profits and Losses - Profits and losses are passed through to the partners as specified in the partnership agreement. If left unspecified, profits and losses are shared equally among the partners.

  • Management Control and Decision-Making - As a general rule, all partners share equally in the right and responsibility to manage and control the business. A formal agreement may delegate some decisions or duties to certain partners, but ultimate responsibility rests with all partners.

  • Financing Startup and Operation - In most cases, a partnership will be able to raise capital more easily than a sole proprietorship, but not as easily as a corporation. The borrowing power of each partner may be pooled to raise capital, or additional partners may be admitted to increase borrowing power. Assets of the individual partners are used to secure loans.

  • Transferability of Ownership Interest - Transfer of a partner’s ownership in a business is determined by the partnership agreement – or by state law if there is no formal agreement. There are other rules about how – or if – new partners may be admitted.

  • Government Regulation - A general partnership, like a sole proprietorship, operates with relatively few government controls. Most issues are determined by the partnership agreement. No special partnership reports or filings with government are required. The Revised Uniform Partnership Act (RUPA) provides rules for basic questions of partnership management.

  • Tax Considerations - The partnership itself is not a taxable entity. It serves as a conduit to pass income, deductions and credits to individual partners. Each partner is taxed on his or her share as defined in the partnership agreement.

Forming a General Partnership

There are a few different kinds of business partnerships. They vary in legal structure depending whether – or how – the liability of partners can be limited. Today, we’re touching only on the basics of forming a general partnership.

A general partnership is a business (that is not a corporate entity) that is owned by two or more people. Under state law, general partnerships have specific attributes:

  • Each partner shares equally in the right, and responsibility, to manage the business
  • Each partner is responsible for all the debts and obligations of the business

Regulatory Requirements

A partnership must obtain business licenses when necessary. Not all businesses are regulated or require a license to operate in Minnesota. To find out if the business you’re considering requires a license, certification or permit, visit the License Minnesota website.

Partnerships must also obtain federal and state tax identification numbers; an unemployment insurance employer account number; and may need to register the business name as an assumed name, unless the first and last name of each partner is included in the name of the partnership.

Although the partnership itself is not a taxable entity, it must file an annual federal and state “information” return with the Internal Revenue Service and the Minnesota Department of Revenue.

For this reason, both federal and state tax identification numbers must be obtained. A partnership that will be selling a product or service that is subject to sales tax also will need to register for purposes of Minnesota sales and use tax.

Obtain the federal employer identification number first. You do it by filing Form SS-4 with the Internal Revenue Service. Download Form SS-4. Download the SS-4 Instructions.

You can apply for a state tax ID number online,by phone or by filing a paper form through the Minnesota Department of Revenue. To apply online, you’ll need your federal employer ID number (FEIN), if applicable; the legal name or sole proprietor name and business address; the business name (Certificate of Assumed Name), if applicable; the North American Industry Classification Code (NAICS); and the name and Social Security number of the sole proprietor

The Partnership Agreement

Like marriages, business partnerships can be happy, productive, and last for decades. They can be turbulent, fraught with difficulty and end unhappily. Or they can be a little bit of both.

Of course, the success of any business partnership depends on the skills of the partners and how well they work together to manage the challenges they face.

But the foundation of that success is laid with a rock-solid partnership agreement that spells out the key managerial and operational details of the business. This is not a handshake arrangement or a verbal agreement, but a carefully thought-out, formalized, written document.

The partnership agreement addresses a number of issues relating to the management and operation of the partnership. In drawing up the partnership agreement, each of the prospective partners should consult with legal counsel to assure their needs and relevant legal issues are addressed. Some of the issues typically addressed in a partnership agreement include:

  • Name of the partnership.
  • Duration of the partnership.
  • Location of its place of business.
  • Capital contribution of each partner.
  • Whether partners may make (or may be required to make) additional capital contributions.
  • The level at which capital accounts of the partners must be maintained.
  • Participation of each partner in profits and losses.
  • The amounts of any regular drawings against profits.
  • Responsibilities and authority of each partner.
  • Amount of time to be contributed by each partner.
  • Prohibition of partners’ outside business activities which would compete with the partnership business.
  • Name of the managing partner and method for resolving management disputes.
  • Procedure for admitting new partners.
  • Method of determining the value of goodwill in the business, in case of death, incompetence, or withdrawal of a partner or dissolution of the partnership for any other reason.
  • Method of liquidating the interest of a deceased or retiring partner.
  • Circumstances under which a partner must withdraw from active participation, and arrangements for adjusting the partner’s salary and equity.
  • Whether or not surviving partners have the right to continue using the name of a deceased partner in the partnership name.
  • Basis for expulsion of a partner, method of notification of expulsion, and the disposition of any losses that arise from the delinquency of such a partner.
  • Period of time in which retiring or withdrawing partners may not engage in a competing business.
  • Procedures for handling the protracted disability of a partner.
  • How partnership accounts are to be kept.
  • Whether or not interest is to be paid on the debit and credit balances in the partners’ accounts.
  • Where the partnership cash is to be deposited and who may sign checks.
  • Under what conditions limited partners may be accepted into the firm, and, if so, who shall be designated as the general partner.
  • Prohibition of the partners’ pledging, selling, hypothecating, or in any manner transferring their interest in the partnership except to other partners.
  • Identification of material contracts or agreements affecting the liability or operation of the partnership.

Remember, it is impossible to pay too much attention to the partnership agreement when forming your business partnership. Also, nothing we cover here should be taken as business or legal advice. It’s not. And it’s no substitute for the professional guidance of a lawyer or accountant.

Learn More 

Consultants at our Small Business Assistance Office can help you understand more about partnerships. And our network of Small Business Development Centers has experts located in nine main regional offices and several satellite centers statewide.

For a comprehensive look at partnerships, see our Guide to Starting a Business in Minnesota . Available for download in PDF, formatted for e-readers, or available in print (all free of charge), the book covers the major issues, questions and concerns about business startups.