Adding a partner to an existing business often results in dynamic changes in the organization. Financial and legal implications arise with bringing a new partner into an existing business.

Bringing in Partners

When two or more individuals share responsibility for running a business, this is known as a partnership. A partnership is a business organization owned by two or more individuals. Some examples of popular businesses that began as partnerships include:

  • Microsoft: Paul Allen and Bill Gates.
  • Disney: Roy and Walt.
  • Ben & Jerry's: Ben Cohen and Jerry Greenfield.

Although these businesses originated as small partnerships, they quickly grew to multi-national corporation status through an incredible amount of energy and creativity. Partnerships that run successfully work like a well-played orchestra. When it doesn't perform, it's similar to a scene from Titanic. Unfortunately, it's hard to foresee how a partnership will work out until it's actually created and operating.

Creating a Partnership

Each partner contributes some form of expertise, skill, and a certain degree of effort in order to share in the company's profits. A partnership agreement will lay out the terms for creating a partnership. This form of business relationship offers many unique resources that each member can bring to the company. The main advantage to starting a partnership is the ease in forming and administrating the business structure.

Remember, it's highly recommended to have a qualified attorney review the partnership agreement before signing it. Each partner is legally recognized as an owner and can operate the business, borrow money, and hire employees

Advantage of Partnership

The advantages of creating a partnership include:

  • Partnerships allow sole proprietors to take advantage of the efforts, expertise, and skills of more than just one person.
  • It allocates the risk across more than one owner.
  • Partners provide support and a stimulating social environment.
  • The government has very little legislative influence or direct control over partnerships.
  • The expenses are allocated across all partners.

Disadvantage of Partnership

The disadvantages of creating a partnership include:

  • Discourse will arise between partners.
  • All partners are legally responsible for the actions of other partners, including borrowing money, hiring employees, and running the partnership.

Just as in any close relationship, partners will often have quarrels and disagreements. Similar to a divorce, when a partnership dissolves things tend to get a bit messy. Remember, expenses and profits are allocated across all partners.

Is There a Way to Avoid Personal Liability?

Forming an LLC partnership allows owners to avoid personal liability. It's a bit more complicated in an LLC or corporation to bring on a new partner. The conversion process for an LLC from a single-member to a multi-member entails the following:

  • Filing tax forms associated with operating a partnership.
  • Amending the operating agreement to address:
    • The amount of capital the new partner is investing in the LLC,
    • The new partner's compensation,
    • The new partner's role and responsibilities.
  • Typically, there's no need to report any new members to the government until the annual report is due.

It's not very complicated to bring on another partner when the business structure is a sole proprietorship. The most important step in the conversion process is filing for a Federal Employee Identification Number (FEIN). In a partnership, one owner is not allowed to use their Social Security number when registering their FEIN because there are now two owners.

How to Report Business Earnings and Losses?

Use Form 1065, U.S. Return of Partnership Income, to report the partnership's losses and earnings. Also, file the individual K-1 to reflect each partner's portion. Although a partnership agreement is not legally required, the benefits to creating one include laying out rules and guidelines to how:

  • The partnership will be operated.
  • Disputes will be resolved.
  • The company will be dissolved.

The Structure and Costs of Bringing in a Partner

There are two classes of partners. They are:

  • General partners: Make decisions and maintain liability.
  • Limited partners: Raise most of the capital and retain limited liability.

All partners will pay taxes on their allocated share of the profits.

Liability for Partnerships and LLCs

The most important difference between partnerships and LLCs is in their liability protection. Each partner is personally liable for the partnership's debts. Furthermore, every partner is personally liable for all other partners' actions. LLCs are created precisely to protect its members from liability (as the term “limited liability” refers to). In an LLC, members are only liable to the degree of their personal investment for the business' debts.

If you need help with adding a partner to an existing business, you can post your legal need to UpCounsel's marketplace. Upcounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.