You have the idea and vision. You saw a need, a problem in need of a solution. You know what would solve this problem. You have lined up a few partners to form the business that will deliver the answer to those that need it. Your mind is racing with possibilities.
While this is an exciting time, you do need to take care of a few business basics. You have to form a business. Since there are multiple people involved, one aspect of creating a business includes how to decide partnership percentage. We will look at the steps you need to take. Let’s tackle some more “philosophical” questions first.
What Kind of Partnership Meets Your Needs?
Financial contribution is essential, obviously, but so is the role each partner will play in the business. The nature of your responsibilities can be a factor in the percentage.
Who will be running the day-to-day operations? Is everyone investing in the business and will be working each day? If so, who is doing what (marketing, product creation, legal, work, etc.)? Is one partner running the business (sometimes referred to as “sweat equity”) while the others are contributing start-up money in exchange for higher profit share? These are the questions you need to answer to determine how the business will be structured.
There are four major types of businesses you can form – sole proprietorship, partnership, corporation, and limited liability company (also referred to as LLC). This discussion focuses on the partnership option. Within the heading of “partnership,” there are three main types of structure – the general partnership, the limited partnership, and the limited liability partnership.
General Partnership (GP)
The website Investopedia defines a General Partnership as “A general partnership is a business arrangement by which two or more individuals agree to share in all assets, profits, and financial and legal liabilities of a jointly-owned business.” There is no limit to liability – each partner can be held liable for the business debts, and any partner can be singled out for legal action.
An example of a general partnership could look like this: Two people decided to open a clothing store. They come up with a name. At this point, they have a general partnership. As soon as they conduct some business activity, such as buying inventory or signing a lease on store space, the company is officially in business.
Limited Partnership (LP)
A Limited Partnership is a partnership where some partners contribute only financially to the business. Within this structure, there is at least one limited partner and one general partner. The general partner will be responsible for the day-to-day activities of the business. The finance-only partners can only be held liable up to the dollar amount of their financial contribution.
An example of a limited partnership could be a restaurant. A chef or business person would be the general partner, and someone who contributes financially to help the restaurant open would be the limited partner. The general partner runs the restaurant and provides regular updates to the limited partner. If the restaurant fails, the limited partner is only liable for losses up to the amount of the financial contribution.
Limited Liability Partnership (LLP)
A Limited Liability Partnership is a business organization that allows limited partners to enjoy limited personal liability, while general partners have unlimited personal responsibility. Just like with limited partnerships, the limited partner(s) cannot have any role in the daily activities of the business. The tax implications for limited partners can be more complicated in this setup.
This is a typical setup for professions that require professional licenses to conduct their business. As such, individuals would want to be protected from things like accusations of malpractice against one of the other partners. This would include such occupations as physicians, attorneys, accountants, architects, licensed financial advisers, veterinarians, and undertakers.
A Partnership Has Benefits
There are definite advantages to forming a partnership. Some of these include the ease of conducting business, simplicity of structure, and absence of piles of paperwork. Things that are simple take just a few steps and don’t cost a lot are always appealing.
It Is Easy and Inexpensive to Set Up
There is no state filing required. You simply agree on a partnership, and it is brought into existence by merely beginning to conduct business activity. It is wise to write down all the details of the collaboration in an agreement before you start (more on that later), but there are no legal requirements to file paperwork with the government.
You Choose Who You Work With
When you work as an employee of a company, you don’t get to choose your colleagues. Everyone has a few stories about co-workers that were impossible to work with because their habits were so different, or their level of discipline and work ethic did not match. There are also the company rules that can make it difficult to innovate or solve problems quickly.
This is not the case when starting a new business. You get to choose who you have as your business partner. It could be a trusted friend, a specialist who is an expert in the field of your business, or perhaps a fellow employee of a company who shares your desire to start something new. It could be a crew of six people that have a common goal to make the world around them radically different.
Paperwork Is Light
Who enjoys plowing through vast piles of papers and forms? Practically no one. With partnerships, paperwork is not a significant burden.
Tax filing is relatively simple. The partnership files an informational return, and the partners report income and losses on their personal tax forms. This is known as a “pass-through” business.
Things that corporations are required to do, such as annual meetings, official company officers, and extensive documentation separating personal and company assets, are not needed with partnerships. The structure is as simple as you design it to be.
Expansion Is Easy
What is one of the best problems a new business can have? Being so successful that there are not enough people to do all the required work.
If you find that you need to hire additional people, doing so is relatively simple. Hiring employees is not the same as bringing in other partners. If you only need one or two more people, you can advertise, screen the applicants, and make a hire.
You could add an incentive for the new employee to become a partner later on if you want to, but you aren’t required to formally alter the structure of the partnership when you hire an employee to work under you.
It’s a Good Option for Short-Term Projects
If you have a single project to handle, a partnership can be the ideal structure. Rather than start a formal company that binds everyone together for a long time, you can ally to work on the project, then end the partnership so everyone can move on to other things.
Examples would include family estate planning, making a movie by forming a Limited Partnership until the film is completed. Other project partnerships could consist of co-writing a book, creating and launching an application, hosting a co-branded webinar, or launching a course.
This is also a great way to build your business network. If someone else needs a project partner, you could be referred to them by a previous project partner who worked with you that gave you a glowing endorsement.
There Are Things to Guard Against
On the flip side, there are disadvantages of a partnership. These are unpleasant things that no one wants to think about, especially during the excitement of starting a business. However, sometimes bad things happen. You need to be prepared for them.
There Are No Liability Limits
Any individual can be held liable for all debt and obligations of the partnership. Each partner is ‘jointly and severally’ liable for the partnership’s debts – in other words, each partner is responsible for their share of the partnership debts as well as being accountable for all the liabilities. Further, your assets could be at risk if the business fails.
Access to Capital Could Be Limited
It is likely that when forming a partnership, one or all of the partners are contributing to financing. But if you begin conducting business and later find yourself in need of additional capital, it may be challenging to find it. Banks will be more hesitant to lend to partnerships than they are to an LLC or a corporation.
There Is a Lack of Stability
If one partner encounters a significant life change that requires that partner to change his/her role in the business significantly, the landscape of the partnership is dramatically altered.
If one partner has a family member that suffers a severe injury or illness and must devote more time and/or energy to care for that person, the business partnership could see significant change or have to be dissolved completely. That lack of stability could be a source of stress for all partners.
Decision-Making Could Be Slower
This is mainly a comparison to sole proprietorships or an LLC with only one person. With partnerships, you have to build consensus among the partners on important decisions. This may take some time, making the process move more slowly.
There Could Be Future Selling Complications
Whatever form your business takes, you should have a solid exit strategy in place. If some part of your environment changes and one partner wishes to sell the company, this can cause conflict if only this one partner wants to sell.
With a partnership, one partner cannot sell the entire business without the other partner(s) consenting. However, a partner can sell his/her portion of the company to anyone. If the relationships have become strained, one partner can sell and exit without the consent of the rest of the partnership.
This could get very complicated if the scenario isn’t covered in the initial partnership agreement.
There Could Be Emotional Issues
Several complications can arise when working with others. Some highly-charged emotions may come to the forefront.
There can be an unequal effort, or the perception of uneven effort, in conducting the regular activities of the business. If one person is perceived not to be carrying a proper share of the load, conflict can escalate quickly.
You may have substantial differences of opinion that present roadblocks. If there are signs that the structure is no longer meeting the needs of the business, the partners may differ on what changes need to be made. Strong alliances with a specific course of action could make it very difficult to make the necessary changes.
Since we’re all human beings, there is always the possibility that a relationship will go sour. If the partners are family members or spouses, a deterioration in the relationship can get very emotionally charged and lead to impulsive or vindictive decisions.
If dispute resolution is not part of the original partnership agreement, the business could be paralyzed entirely by legal action partners could take against each other.
Many people start new businesses as corporations or limited liability companies (LLC) to protect against these types of pitfalls. Forming an LLC or corporation involves more work and start-up costs, but also provides more excellent protection for all of the partners. A writer for entrepreneur.com highly recommends the LLC form.
This list isn’t meant to frighten anyone away from forming a partnership, but just to ensure you are fully aware of what could happen. Every business is different, and some may need a partnership form. If you decide the partnership is the best option for your business, it’s now time to start writing things out.
Plot Your Strategy First
The first thing to do is to plan your business strategy. OPEN Forum community member Bennett Johnson, a small-business strategist and entrepreneur coach, has some advice.
“Find an expert to help guide you in making a plan for the partnership,” Johnson says. “That guidance should include a checklist of your strengths and weaknesses, as well as those as a team. Keep an open mind about the partnership and remove the emotions.” (There are those emotions again!)
A writer for Inc. magazine listed six steps to creating a successful strategy. They include:
Align Your Core Values
You want this as part of any close relationship. You want to work with someone that upholds the same standards as you and believes in what you believe in. This is critical to the success of the business.
Have a Long-Term Shared Purpose
Why do we want to form this business? What do we hope to accomplish? Partners need to be aligned in their visions for the future direction and impact of the company.
Ensure You Have Complementary Strengths
You should expect to excel at different things. You don’t need a clone of you. If one partner thinks about the big picture and is the lead strategist, the other partner ideally will excel in operations and implementation. The goal is for partners to fill each other’s gaps.
Engage in Proactive, Intentional Communication
Let’s say you have these first three things all in sync, but you don’t prioritize communication. If that stays in place, you will come up very short. Partners must be willing to have difficult conversations. They need to feel comfortable talking about anything business-related.
There should be regular standing meetings, in addition to the conversations that naturally occur during the business day. That way, you have a dedicated time/space to address any topics that may be overlooked.
Schedule Strategic Planning Sessions
In addition to the regular standing meetings, partners will benefit from setting aside strategic planning sessions to review the business progress against clearly defined goals. Decide how often to have these sessions – every six weeks, every quarter, whatever works best.
They need to be more frequent than annually or semi-annually. You take 4-6 hours to step back, reflect on what the business has accomplished, discuss potential changes in direction, and set short-term goals that roll up to long-term goals.
Write a Partnership Agreement
You should protect the business and the partners with a partnership agreement. No one expects a partnership to go south, but it happens.
Make sure to pre-determine the percentage split. Unless one partner is infusing a lot of capital into the partnership, consider a 50-50 division, rather than creating a situation where one partner is superior to the other. There is an excellent benefit in “standing shoulder-to-shoulder,” which equally values both people and doesn’t make one partner feel “less.”
What Does Each Partner Own?
After considering the options, you have decided to go with forming a partnership. Now you need to know how to determine a partnership percentage. An excellent place to start is deciding how much each partner owns.
What Is the Value of the Business?
What is this new business worth? The short answer is, the company is worth whatever the partners agree. There isn’t much to go on when deciding what a new company is worth. How much money is being invested is where many companies start. If there are three partners, two of which are spending $25,000, and the third is investing $10,000, you could simply determine the business is worth $60,000.
What Is Each Partner’s Share?
Next, determine how much of the business each partner owns. The Houston Chronicle recommends that you start by calculating the percentage of financial contribution to the company. For example, if all the partners’ contributions total $50,000, and you have contributed $13,000 of that, then you have added 26% of the funds.
Some of this is decided when you determine what structure to use for the business. If you are using a limited partnership, the limited partners that are making the majority of the financial contribution will own a larger share of the company than the general partners. A general partnership may be divided equally, with each partner contributing the same amount of financing, and each partner has a role in the day-to-day operations.
Be Prepared to Make Changes
Remember, it’s difficult to determine the worth of a start-up accurately. It is likely that once the business has been around for a while, you will see some shortcomings in that initial structure. All partners should expect that some adjustments will be needed.
Change in Partners
In the course of running the business, or a difference in the life situation of one or more partners, it may be necessary to add or remove partners within the partnership.
When adding a partner, the new partner can buy out one or more partners with a financial contribution. The current partners can also simply add the latest partner to the group, increasing the number of partners.
There may be a need for one partner to exit the business simply. Unfortunately, it may be necessary for a partner to be expelled from the company. You should include procedures for this when drafting your original partnership agreement. This is one of those instances where having the agreement in writing will save a lot of trouble later on if something unfortunate happens. In the event such contingencies are not written in the original document, the partnership must be dissolved to expel a partner.
Note that if a partnership has two partners, and one simply decides to stop participating in the business, a partnership cannot have only one partner. If nothing was written about dissolving the company in the beginning, the organization simply ceases to exist when one partner departs.
At that point, the business becomes a sole proprietorship if there was no formal agreement set up when the company first started. (Note that this is another example of poor business practice. Having a written agreement, even if you are just forming a general partnership, is always the more sound way to go.)
Change in Structure
Let’s examine positive development. Suppose your business grows. Let’s say it produces a lot. Now your business has different needs. You may need more significant financing or want to bring in a new investor. It may be necessary to hire more employees. The current partners may wish to have protection from increased liability.
These are fantastic problems to have. The simplest way to address them is to change your business to a corporation or Limited Liability Corporation (LLC). This will begin with filing paperwork with your state government and ensuring a thorough business agreement is written out to cover how roles and activity will change.
Of the two options, the LLC is the simpler one, and likely the better option if the ownership group is one or a small number of people. Corporations require multiple officers and a board of directors and are the better option if the ownership group is more substantial.
Review Regularly
Being proactive is always better than being reactive. In your initial partnership agreement, build in regular intervals to review where you will examine your structure to ensure it is meeting the current business needs.
You can use time intervals, such as quarterly or annually. You can set revenue or profit targets to trigger a review of the business structure. Regular meetings with legal counsel can also help determine when changes may be needed.
The key is not letting you and your partners be caught by surprise. Keeping one eye on what is happening in the business today, and one eye on what the future may hold will keep you in the best position to ensure success.
Work the Business, Not the Structure
You have probably noticed a few things being repeated throughout this discussion. Write things down. Communicate constantly. Don’t let emotions make your decisions. Plan ahead. Assess often. Don’t let emotions make your decisions. (Did we say that already? Yes, it is that important.)
Once you and your partners have agreed on how to decide partnership percentage, pour all your energy into making the business succeed.
Embrace the role you have in the business. If you are in the day-to-day activities of providing your product or service, make it the best product or service a customer can have. If you’re a limited partner, be the general partner’s biggest cheerleader.
You certainly want to be aware of what’s happening and to speak up and give honest feedback if you see something going wrong. But you also want to be doing everything you can within your role to generate a positive outcome.
Do not fall into the trap of obsessing over the structure and slipping into analysis paralysis. If you find yourself asking questions like “How much did we make? Am I getting my fair share? Are the other partners getting too much?”, your focus is not in the right place. As entrepreneur.com says, “concentrate on making the pie bigger, not on continuing to try to divide it up.”
Go back to that original motivation to start the partnership. Remember that ultimate goal – providing an essential product or service to people and/or businesses, to work a project or solve a problem, to produce something that makes the world a better place, Try to let that ultimate goal drive you forward.