If you are already in a partnership and it is working well, there is no reason to change what you are doing. This blog covers what to consider if you are thinking about or exploring the idea of forming a future partnership and whether collaboration could work instead. 

Partnerships can be complicated legally, financially and emotionally. They are like marriage or buying a home with someone, you are entangling your life with another person or persons, and just like when you decide to marry or buy a home, you want to make a complete, thoughtful and good decision.

Before jumping into a partnership agreement, consider if a collaboration could work instead or if a partnership is truly best. If instead of partnership or collaboration you are considering hiring, read these blogs: Hiring an Employee and Employee or Independent Contractor.

Collaboration

A collaboration is a formal or informal relationship between two businesses that has usually carries less of a legal, financial and emotional connection than a partnership. With a collaboration you retain the structure and control over your own business.

Legal agreement

You will benefit from having a formal, legal collaboration agreement which requires using an attorney who practices in your state(s). This agreement covers what you will share and not share legally, rights and responsibilities of each business and how revenues and costs are shared. It keeps your businesses separate and intact, provides a plan for disputes that cannot be resolved on your own and covers how to end the collaboration if needed. 

Advantages & disadvantages

A collaboration with limited shared activities can be simpler and easier than forming a partnership. The advantages include: 

• Retain autonomy over your core business. Although there is some negotiation and compromise on certain decisions, a large number of decisions are your own to make. 
• It is clear what each business earned since each maintains separate bank accounts and separate accounting systems. 
• Fewer legal costs since the agreement only covers certain business activities and the agreement does not need to be revised when there is a tax law change affecting partnerships. 
• You each file your own separate taxes, no shared tax return.
• If you decide to elect to be taxed as an S-Corp at some point, this does not affect how the business you collaborate with is taxed and you can decide solely based on what is best for you for taxes.

The one main downside to a collaboration is that it has increased operational cost because each business maintains its own systems, software, banking and accounting. The lack of shared systems means some duplication of costs. 

When collaboration works best

A collaboration works best when this type of arrangements meets the needs of both business owners and each of their goals. Beware that attorneys and accountants often steer business owners to more complicated and costly options. This happens either because the professionals will be able to charge higher fees or because they enjoy working with the complexity. I've found business owners thrive more when they choose the simplest and least costly option that meets their needs. 

Partnership

A partnership is a shared business between two or more people or companies. Think of a partnership like a business marriage. Even if you have a great business idea, a partnership requires maintaining a stable relationship with your partner(s) in order for the partnership to be successful. 

Legal agreement

You need a formal, legal partnership agreement which requires using an attorney who practices in your state(s). This agreement covers initial and ongoing partnership contributions, day to day responsibilities, ownership percent and how to split profits, distributions and guaranteed payments, dispute resolution and what would happen if one partner wants to sell their share or leave the partnership, or if one partner is ill and can't work or passes away.

The agreement can have tax implications and may need to be updated when the tax laws change. For example, in 2018 the Qualified Business Income deduction was created in the tax law but guaranteed payments were not eligible for this deduction, so many partnerships changed their partnership agreements to remove the guaranteed payments. The agreement and any updates need to be provided to the tax professional preparing the partnership tax return. 

Advantages & disadvantages

Because partnerships are more complex, there are more disadvantages. A partnership may still be the best option but you want to go in with your eyes open and do what you can to guard against the disadvantages by having clear expectations and many discussions. Disadvantages include: 

• Less autonomy for the partners. There is negotiating and compromising on small and large decisions. 
• If profits are split equally but one partner does not end up working or putting in similar effort as the other partners, it is difficult to see the lower-effort partner get the same income. 
• If the profits will be split unequally, it can be a lot of work to separately track separate revenues and expenses by person within the same accounting system. 
• Requirement to file a partnership Form 1065 tax return each March 15th and associated cost to pay someone to file this return. 
• Legal costs to setup and periodically revise the partnership agreement.
• If you decide to elect S-Corp at some point, the profits must be paid equally to all partners. S-Corp taxation may benefit some partners more than others. 

The one main advantage to partnership over collaboration is cost savings. Since there is one set of business systems, software, banking and accounting, there is no duplication of costs. 

When partnership works best

Partnerships work best when the partners have a strong, long-term relationship and experience the factors below. While this doesn't guarantee a partnership will go well, these factors help. If you don't have these factors, a partnership may have more risk. 

• You have worked together for years, such as at a prior employer, and you have seen each other in a wide variety of situations.
• When you've been through tough times together, your views remained aligned. It's easier to get along when things are going well. It's a different level when you can get along in difficult times when stress is higher.  
• You have a similar sense of humor and laugh a lot. Being in a business marriage... I mean partnership... can be difficult and being able to laugh together really helps. 

Examples

Although there are countless situations where a collaboration or partnership is best, here are three examples to consider. 

Jamie and Chris want to share office space and otherwise don't need to share other aspects of their business. They can jointly enter into a lease and agree to share administrative office support costs if the want to. They do not need to combine their businesses to get the benefit of sharing space and support each other's business efforts. 

Casey and Logan want to share more than office space, they also want to share client referrals and operate under a shared business name. After speaking with an attorney they learn they can register a shared business name in their state while maintaining their separate business entities. They also agree to share costs of a website. Casey pays for the business name registration, website and other shared costs. Logan reimburses Casey for 50% of the costs, so they end up each having half the costs. They have a collaboration agreement governing their shared activities, but retain their own separate business and separate profits. 

Petyon and Avery have a business idea and it requires them to work closely together in most aspects of the business. They cannot provide their services as easily if they have two separate systems to manage client activities. They have known each other and worked together for many years, both plan to work full time, they expect that splitting profits 50/50 will work long-term. They have discussed the potential challenges and agree that a partnership will work best for them. 

Sometimes it is clear that either collaboration or partnership will be best in your situation. If you need help figuring out what is best because it's not clear, Simple Profit has two options within the low-cost membership. You can join and submit unlimited questions to get through the decision or sign up for a coaching appointment. Learn more here: https://www.simpleprofit.com/aboutmembership

Business Partnership with Romantic Partners

There are three potential situations with romantic partners also starting a business partnership: legally married, legally married in a community property state and not legally married. You always have the choice of collaboration if that works better, but if you are leaning toward partnership consider these factors: 

• The additional legal costs for the partnership agreement. 
• The additional tax filing costs for the partnership Form 1065 each March 15th if you do not live in a community property state (see exception below if you are in a community property state)
• With a 50/50 partnership you will each get credit for 50% of the profit in the social security system, even if you worked different amounts of time or put in different amount of effort. 
• The additional time spent together which can increase relationship stress. 
• Needing to compromise on business decisions while already compromising on personal decisions. 

If you are legally married and live in a community property state (Arizona, California, Idaho, Louisiana, Nevada, New Mexico and Wisconsin) you have an additional option. You can form a Qualified Joint Venture, where you will be legally a partnership but for taxes you do not have to file the Form 1065. Instead, you each file your 50% of the business revenues and expenses on Schedule C, which is part of your personal tax return. This saves the extra tax filing costs of filing a partnership return each March 15th.

If you are not legally married, from a tax standpoint your partnership will be similar to that of non-romantic business partnerships. You will still file your partnership tax return each March 15th and each file your own separate taxes by April 15th. 

Business partnerships between romantic partners can work great, but with the additional time spent together and the additional number of decisions to make together that may require compromise, it can also create more stress. If the business is going well and the relationship is going well, all is well. If one starts to be a struggle, it will probably affect the other one too.  

Bottom line

 Both collaboration and partnership can be a good choice, but one may be more fitting for your situation. Focus on whether collaboration can meet your individual and business needs or if the complexity of a partnership is necessary. If forming a partnership, consider the potential disadvantages and plan to protect yourself against those by having discussions, setting clear expectations and documenting everything in a legal partnership agreement. If you need help deciding, consider joining the Simple Profit membership to get advice and input from Jennie Schottmiller, CPA.