Question

You and a family member are considering starting a business together. You have a very detailed conversation about your mutual expectations, your business goals, and your respective roles in the business. What items should you discuss with your partner before entering into a business arrangement? What are the most important factors that you believe need to be addressed and agreement upon prior to forming the business?   You are both considering a limited liability company. (LLC). Is an LLC the most appropriate form of business organization? (What about a Partnership, S-Corp or a Sole Proprietorship) Please explain why these are important to you?

Answer 1

Partnerships can seem like the perfect path to business ownership – shared investment, shared effort, and someone to alleviate the risk of “going it alone”. Here are eight questions to ask myself and my potential partner, before we walk down the proverbial “aisle” to business partnership.

Why Are We Doing This?

One made financial decisions without the other and things quickly got nasty leaving a broken partnership and thousands of dollars in unexpected liability on both sides. The point is, unless we are both sure why we are doing this and are equally committed, things can quickly go awry.

Does My Partner Bring Skills to the Table that I Don’t?

Each partner should bring a key skill or experience to the table that the other lacks. A well-rounded team is more likely to attract investors and give the partnership the holistic basis it needs to succeed.

How is My Partner Situated Financially and Personally?

It’s worth being forthright about things like the credit rating of both partners – this will give me an indication as to their fiscal health, but also alert me to any red flags that might impact our ability to get funding.

What Time Investment Can My Partner Give?

We don’t have to commit to an equal amount of hours, but it’s important to understand both our expectations. If we are not in alignment now, there could be problems later.

How Does My Partner React Under Pressure?

I can talk to former employees to get a sense of how they perform under pressure.

What Kind of Brand Do They Project?

I should think of this from both a business and personal standpoint. Our brand isn’t just your logo and signage it’s about the people behind it.

How Will We Divide Profits?

It’s a tricky question, especially if one partner contributes more man hours or injects more money into the business.

Are We Willing to Put It in Writing?

Although an agreement is not legally required, it can protect our interests as one-half of the partnership for the duration of our partnership and through its dissolution. This to include are how we will split profits, any contributions or assets each partner makes to the partnership, how decisions will be made and how disputes will be resolved, as well as who does what.

Businesses set up as partnerships, legal entities where two or more people own and run a business, enable companies to benefit from multiple owners’ diverse knowledge, skills, and resources. So, what should our partnership agreement include? Here’s a list of some key items we should definitely think about addressing in ours:

1. Contributions

In our agreement, we will define what each partner will put forth—not only in the amount of money, but also with regard to time, effort, customers, equipment, etc.

2. Distributions

Outline not only how profits will be distributed, but also define if each partner will be paid a salary (and of course how much that salary will be).

3. Ownership

Agreement should carefully describe how ownership interests would be handled in various scenarios like those and others, such as in the event of any partner’s death, a retirement, or bankruptcy. And to protect our business from a partner leaving, setting up a new company, and stealing your customers, I should also consider adding in a non-compete clause.

4. Decision Making

By setting up a decision-making structure that everyone understands and has agreed to, we will have the foundation for a more friction-free business.

5. Dispute Resolution

Setting up how we will handle disputes will take the guesswork out of navigating dissention.

6. Critical Developments

Partnership agreement should address possible scenarios and concerns, such as:

• A partner getting sick or dying—What happens then?
• A buyout—How will the business be evaluated (and what is the split) if an offer is laid on the table?
• Retirement provisions.
• Circumstances under which you can modify your partnership agreement—and the process for making changes.

7. Dissolution

Agreement should also include what steps should be taken to legally end our partnership. State law governs dissolution and our state’s website should define the process and provide the forms we need to complete.

One of the first decisions you’ll make as a business owners is how our business will be structured. A limited liability company or LLC is a hybrid business structure that provides the limited legal liability of a corporation and the operational flexibility of a partnership or sole proprietorship. LLC is the most appropriate form of business organization due to its following advantages:

- It is the most common business structure and is specifically created for small businesses.
- This entity type requires insurance in case of a suit.
- It is a separate legal entity.
- LLCs are usually taxed as a sole proprietorship.
- LLCs can have an unlimited number of owners.

If we are establishing a partnership, it is extremely important to make sure everything is outlined in case things go sour, especially when starting a business with a loved one or friend. Since, the business is starting with a family member, partnership will lead to the following:

- Partners are jointly and individually liable for other partners’ actions.
- Profits must be shared with the partners.
- Decision making is divided.
- Business can suffer if the detailed partnership agreement is not in place.

An S-corporation, also known as subchapter S-corporation, offers the owners limited liability. But, it also has the following disadvantages:

- It can be costly to form.
- Stockholders are limited to individuals, estates or trustees.
- It is subject to required administrative duties.
- It cannot provide company paid fringe benefits.
- Stockholders are limited to citizens or resident aliens of the United States.

The vast majority of small businesses start out as sole proprietorships. These businesses usually are owned by one person, aka the individual who has day-to-day responsibility for running the business. Doing a sole proprietorship with a family member will lead to the following problems:

- There is unlimited liability if anything happens in the business. Your personal assets are at risk (including your home in Kansas City).
- It is limited in raising funds and the owner might have to acquire consumer loans.
- There is no separate legal status.

Hence, LLC is the most appropriate form of business organization when starting a business with a family member.

All the above things are very important for my future financially as well as personally. So, the above points needs to be considered when starting a business with a family member.