How to Form a Partnership
Heads up: this article is only relevant for U.S. businesses.
A partnership is a unique business structure that allows two or more people to hold shared ownership of a single business.
Each partner is responsible for contributing money, property, labor, or skills. In return, each partner shares in the profits and the losses of the business.
In this guide, we’ll walk you through the pros and cons of the partnership business structure, and share the steps you’ll need to take to form a partnership.
Understanding the partnership business structure
There are three variations of the partnership business structure, each with slightly different features.
This form assumes all contributions and the division of profits and losses are even. If they’re not even, this must be laid out in the partnership agreement.
A slightly more complex version, the limited partnership allows for a partner to have limited management input, as well as limited liability. The extent of their input and liability is determined by their investment percentage.
In order to go into business for a specific period of time, partners will form a joint venture, which functions as a general partnership for the time specified. If the joint venture continues past the time period specified, the partners must file as a general partnership.
Advantages of a partnership
The partnership business structure is an advantageous choice for business owners because it is simple and inexpensive to form. The most complex part of forming a partnership tends to be preparaing the partnership agreement. The other notable advantage is the shared commitment (and liability) that comes along with a partnership.
Disadvantages of a partnership
Challenges tend to arise in partnerships around the division of labor and liability amongst the business owners, and maintaining effective working relationships. There are at least two people making crucial business decisions in a partnership, so the possibility of a disagreement can be high. Partners should make a point of consulting each other on all decisions and learning to compromise early on.
Additionally, the full, shared liability among owners needs to be considered. Partners are responsible for business debts and the decisions made by the other partner(s). Similar to the sole proprietorship business structure, general partnerships are considered an “unlimited liability” business—meaning that all owners’ can be held personally liable if the business runs into financial or legal trouble.
How to form a partnership
Here are the steps you need to take to form a partnership:
1. Register the business
You need to register your business with your state before it starts operating. This is usually done through your local Secretary of State office.
2. Establish the business name
The business’s legal name is either the name given on your partnership agreement, or the last names of the partners. If you’d like to operate under a name other than the business’s legal name, you’ll also need to register a fictitious or Doing Business As (DBA) name.
3. Obtain licenses and permits
The regulations for licenses and permits vary by industry, state, and locality. This licensing and permits tool can help you determine what you need to acquire.
4. Create a partnership agreement
Though the partnership agreement is not legally required, it’s considered risky to do business without one. Discuss potential issues with your business partner(s) at the outset of partnership formation and include your decisions in the agreement. How decisions will be made, how partners will divide profits, how you will resolve disputes, how to change ownership, and how to dissolve the partnership are all key points to consider.
Paying taxes as a partnership
As a business, a partnership does not pay income tax. Instead, profits and losses are passed through to the partners, who are responsible for including their share of the income on their personal tax return. However, partnerships do need to file an annual information return (Form 1065) to report income, deductions, gains, and losses for the business.
This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. Bench assumes no liability for actions taken in reliance upon the information contained herein.