Types of Business Partners and Things to Consider
By: Attorney Michael Jonas
What does it mean to have a formal business partnership?
You may be considering having a business partner for a variety of reasons. People have partners for one or more of the following:
They don’t want to do go about business entrepreneurship alone
They want to work with someone who has different but complementary skills
They want to work with someone with the same skills to present a “stronger together” front
They know someone who has funding or connections or both (and that’s valid)
We have to be careful when we loosely use the word “partner” but especially in the business world. This is because when we hear the word “partner,” we assume that you and the other person share ownership, profit, responsibilities, and liabilities for the business. We also assume that you have fiduciary duties to one another. A fiduciary duty is a form of trust between partners that they will do what is in the best interest of the company they both own. They will also be honest and forthcoming with each other. Partnerships require a variety of fiduciary duties to take place. They are:
Fiduciary Duty of Good Faith and Fair Dealing
Fiduciary Duty of Loyalty
Fiduciary Duty of Care
Fiduciary Duty of Disclosure
If you aren’t ready to have a fiduciary duty to the company and to the other person (your business partner), then you probably shouldn’t be in a business partnership.
What is the difference between general and limited partnerships?
These are generalizations (so keep that in mind), but general partners in a general partnership are usually 40/60 or 50/50 for ownership percentages and day to day operational needs. General partners in a general partnership both tend to have the same or similar liability.
General partners in limited partnerships (where there is one general and one limited partner) have management and day to day operational duties. This is because the limited partner is often an investor and advisor (or both). The word “limited” comes from “limited liability.”
To have a better understanding of this, here’s an example of how general partnerships and limited partnerships differ in both role and responsibility.
General Partnership
Jenna and Carrie have decided to open up a pizza shop. They are both going to be contributing to the formation costs of their new business. Jenna and Carrie will be doing anything and everything for their business to survive (ie. preparing and making pizza, advertising and marketing, and hiring when they are able). Both Jenna and Carrie plan on owning the business 50/50 and splitting the profits and losses 50/50. If Carrie and Jenna default on a commercial lease, go bankrupt, or have a lawsuit filed against them that results in a judgment, both Jenna and Carrie are responsible and liable. On the alternative, they are equally in this, and neither is a limited partner which we will describe next.
Limited Partnership
Let’s say Ryan & John decide to be limited partners for an ice cream shop. Ryan is the general partner and John is a limited partner. John contributed $10,000 for 5% ownership of the ice cream shop. Note that we would call the 5% ownership different terms: it’s called “membership interests” if it’s an LLC, and “equity” if it’s a corporation.
John has owned pizza shops in the past but he doesn’t want a day to day job operating one. He wants to be an investor with some mentor components. Because he’s a limited partner, if the business goes really well, he gets 5% when ownership distributions occur. If things go really bad (ie. commercial lease default, bankruptcy, lawsuit), John will lose his $10,000 investment. His loss is limited to that amount.
We can have multiple partners, not just one. However, we only have 100% of 100%. Meaning, if you have two owners and want to add a third owner, someone has to dilute their ownership percentage. There is something called a “reserve” which allows you to keep ownership available for future investors so that dilution doesn’t have to occur later on. For example, if Ryan takes 80%, John 5%, that accounts for 85% out of 100%. We can keep a reserve of 15% for a future potential investor/partner to come along. This would be set up in the initial partnership agreement, and updated when the time comes.
Again, these are generalizations and defaults. There are tons of variances in partnership organizational, ownership, and profit structures.
What documents and processes are required to form a partnership?
Forming a partnership requires:
1. Registration or updates of a new or existing business entity so that all partners are on state paperwork
2. A partnership agreement between the parties
If you are forming a new business, any partners at the time of formation can be added to the state filing. If you have already formed a business and are adding a partner, you will want to update the business registration to add your partner.
If partners don’t have a business partnership agreement, but act as they are partners, a court (if it gets to that) will call the partnership 50/50. It’s also curious that most states don’t require the filing of a partnership agreement at the time of formation. Regardless of this, we always advise every client to have a written and signed partnership operating agreement.
A partnership operating agreement is a combination document that combines operating terms (ie. company purpose, processes, and procedures) with partnership terms (ie. ownership, roles and responsibilities, profit distribution guideline).
Read our cautionary tale over here: What happens if you don’t have a partnership agreement? https://www.rationalunicornlegalservices.com/blog/what-if-you-dont-have-a-partnership-agreement
So what makes a “good” business partner?
At the beginning of a partnership, it is very important to be on the same page with expectations and to set those in writing with a contract. It can be difficult to talk about the important topics and what ifs, but this is a moment to pause and reflect.
You’ve heard the marriage advice to talk about everything and get on the same page before you get married in order to build a strong foundation together. In business, it’s the same.
If you can’t get through our partnership agreement form/questionnaire together, then you probably shouldn't go into business partnership together. If you’re curious about what types of topics a partnership agreement consists of, take a moment to look through our questionnaire: https://www.rationalunicornlegalservices.com/partnership-questionnaire
It’s okay if you don’t have the answer to all of these questions but you should be at least able to discuss them with your business partner. Perhaps that’s why you hired someone at our law firm to assist. Your business partner is a person you will need to not only do business with, but work with over years. Navigating the hard times and having a process for what to do when you disagree is essential.
Feeling the pressure? The good news is, there are other ways to work together.
Joint Venture
You can work with someone (and when I say someone it can also be your respective businesses) on an event or for a specific project. For example, a concert may be put on by a recording artist, a music producer, and an event venue. They would partner but not on all of their business items (ie. they won’t be sharing profits and losses for everything). The partnership would be limited to the event preparation and the event itself. A joint venture then is a short term partnership for a particular event, project, or time frame. Those involved are called “co-venturers.”
Community Partnership
Community Partners may be two organizations who want to share marketing, programs, and/or resources. For example, a housing nonprofit may partner with a food nonprofit to have a lunch program for those being housed.
Community Partners should have more than a memorandum of understanding. This is because, contrary to popular belief, MOUs are not legally binding. Community partnership agreements are the preferred document that should be in writing and signed. They set forth terms like who will have what responsibilities, who will take on liability that may arise, and how resources will be used or allocated.
Hiring the Other Person As A Contractor or Employee
If you want to work with another person or business but don’t want them to share in profits. Or, you don’t know if you want them to be a business partner, it is possible to hire a contractor or employee. Maybe that’s the role they maintain. Or, maybe you and the hired contractor and employee love working with one another and decide to become business partners in some capacity.
Long story short
Having business partners can be efficient, fun, and financially rewarding. However, it can also be a trainwreck or what I like to call a clusterfuck of chaos (I’m not sure if that’s trademarkable). The takeaway is: Do not take the decision to have a business partner lightly especially if it involves giving them a large percentage of ownership in your business. And always sign your partnership agreement after you have both reviewed it.
Further Reading:
https://www.rationalunicornlegalservices.com/blog/what-if-you-dont-have-a-partnership-agreement
https://www.rationalunicornlegalservices.com/blog/why-you-need-a-operating-agreement