If you’re starting a business and have one or more partners, it might seem obvious to form a business partnership.
Even though forming a partnership might make sense, it’s not your only option. As an entrepreneur in Canada, you can run a business as a sole proprietorship, a corporation, or a partnership. The decision of how to structure your business depends on the needs and future goals of the business, the availability of funds, and other various factors. Before you commit and form a partnership, it’s important to understand the advantages and disadvantages of this type of business structure. So, what are the pros and cons of a business partnership?
PROS of a Business Partnership
Reduced Financial Strain
A business partnership is inexpensive to set up and any income earned will be accredited to the partners for income tax purposes. In a partnership, all partners can contribute towards raising capital funds and multiple owners make it easier to borrow than sole proprietorship, since a combined credit rating is (hopefully!) stronger. Partners pay their personal income taxes on their share of the profits from the business, rather than have to bear the burden of all the taxes alone, like in a sole proprietorship.
Additional Expertise
A balanced business partnership combines skills, knowledge, and different experiences which makes for more contacts and capabilities. Whether your potential partner’s talents complement or contrast with your own, they can significantly boost opportunities for growth, and higher profits. As well, working with a business partner allows you to divide up tasks according to strengths, which saves time and effort.
Another Perspective
Our egos wants us to believe that we have all the answers, and that our way is the best way. While your perspective matters, it’s important to realize that it is limited by your own background and experiences. It’s true for everyone. Want to avoid tunnel vision? Having a business partner can make decision-making more realistic when two or more people weigh in on ideas and share their concerns and feedback. Of course, remember the value of other perspectives when you hire employees, as cultural diversity in the workplace is a valuable commodity. Companies that make diversity a priority offer a variety of ideas, learning opportunities, and inventive solutions.
CONS of a Business Partnership
Giving Up Power
Partnerships are not a separate legal entity from the business owners, so partners are personally responsible for the obligations of the business. Each partner is personally liable for the debt obligations of the business, including those obligations entered into by only one of the business partners. So, if your partner signs a contract on behalf of the business and the business can’t fulfill those obligations, the other company “creditor” can “enforce a judgement” against your personal assets regardless of whether you personally signed that contract. And, if your partner skips town, you’ll be liable for all the debts, not just half of them. Gulp. If giving this power to a partner scares you, consider incorporating your business to lower the amount of personal liability you expose yourself to.
Potential Conflict
Working with friends in business can be an enjoyable experience. It can also be a real challenge. Just as no one enters into marriage thinking it will irreparably sour, no one enters a business partnership thinking it won’t survive.
With entrepreneurial excitement, it can seem absolutely logical to partner with a friend. However, many people underestimate the stress a business will put on friendships and family members. Unfortunately, many life-long friendships have been ruined from business relationships gone bad. Some people are best kept as friends. Sometimes differing views on fundamental business decisions highlight the bad and the ugly.
When assessing a friend as a potential business partner, there are a few key characteristics you should look for.
- Integrity – It doesn’t matter if you’ve known the person since Kindergarten, if the person lacks integrity, bringing them onboard is just too risky. Will this partner do the right thing in every situation, whether it’s convenient or not? Pay attention to how they make decisions when no one watches over them. Are they so competitive that they have rationalized lying, cheating, and/or bribing someone to get what they want?
- Strong Work Ethic – Being a small business owner and entrepreneur is one of the most stressful challenges a person can undertake. Accordingly, anyone you consider as a partner must have a serious work ethic. Even when you set expectations for roles upfront, one of the biggest reasons for contention between business partners is one person feeling like they are handling all the work. So, ignore what a potential partner says they are going to do, focus on whether they have a track record of producing results.
- Perseverance – Many would-be entrepreneurs have great ideas, but you need someone by your side that will remain persistent and dedicated through hard times. It can take years to see the fruits of all your work. Does this person have not only the vision and know-how, but also the stamina to be in it for the long haul?
Splitting Profits
When you have a partnership, you have to share the profits. Unfortunately, talking about sharing profits equitably brings about difficult, awkward, questions. How do you value each partners’ respective skills? What happens when one partner is seen to be putting in less time and effort into the partnership, but still taking a good share of the profits? It’s easy for resentment to develop if there doesn’t seem to be a fair balance between effort and reward.
If you do decide to enter a business partnership, make sure to decide ahead of time—in writing— how profits from your business will be split. What percentage of profit will each partner receive? What percentage of loss will each partner take if the business loses money? What kind of payment will each partner receive?
Document all cash, equipment, property, and any other personal assets that a partner is donating to the business. Delegate duties so that everyone knows who is responsible for each task. Decide how much decision-making authority each partner should have and how you’re going to handle decisions for the business and the potential future dissolution of the business.
Whatever the reason is, if you want to keep your business, but your partner has to go, you will have to buy out your business partner. This can be costly. But, it may be even costlier without a dissolution strategy, so write one up front. Think of your dissolution strategy like a prenuptial agreement for your business partnership. It makes for a clear exit strategy from the beginning, while everyone is on good terms. You do not want to be stuck negotiating how to part ways if things go south and there’s animosity. Sure, you can buy out your partner without an initial partnership agreement, but it will certainly make things messier.
You will also need to notify (at minimum) your:
- Lawyer to review the legal aspects of your partnership agreement
- Accountant to assess records, transactions, liabilities, assets, and accounts
- Provincial government to update your business registration
- Bank to change your business structure and update accounts and loan agreements
With good planning and consideration of the pros and cons of business partnership, though, this business structure can be a great success. It is the simplest and least expensive co-owned business arrangement. And, the additional expertise, talent and perspective can really help a business grow. Of course, sharing financial obligations may cost you if you choose the wrong partner. If you are confident your potential partner has great integrity, work ethic and perseverance, make sure to have all the awkward conversations. How will profits be split? Who is responsible for each duty? How much decision making authority does each partner have? Document all incoming assets and figure out an exit strategy. It’s always best to be professional and prepared, so that you can move your business forward from the best possible position.
Business Partner Evaluation Checklist
- Do you share a clear vision and common goals?
- Is there enough trust and respect?
- Is the value added by this partnership greater than the sum of individual contributions?
- What are your shared values, and what do they mean?
- Can you leverage their expertise, talents, and resources? Can they leverage yours?
- What will each partner contribute, and what do they get in return?
- Are they willing to share costs and risks?
- Are they committed to following through with perseverance and a strong work ethic?
- Will they act with integrity and have a high moral standard?
- Can you communicate effectively in an open and transparent way?
- Have potential risks/conflicts been considered and mitigated?
- Have responsibilities been agreed upon, along with the division of profits?
- Have you decided who can make which decisions and how they will be reinforced?
- How will you fill in support functions, by outsourcing or hiring staff?
- What are each partners’ financial contributions?
- What is the cost structure and what are your income targets?
- Are partners’ financial return expectations aligned?
- Have they agreed to a written agreement, including an exit strategy?