Small Business Taxes & Management^TM--Copyright 2010, A/N Group, Inc.

Taking on a partner (or shareholder, LLC member, etc.) should never be done casually. There are a host of factors to consider--can you get along with him or her on a daily basis? Will the extra business be worth the split of profits? The problems can easily outweigh the benefits. Before taking on a partner--or a shareholder, consider the following.

Make sure you're compatible. Sounds obvious, but you'll be surprised how many small business owners don't consider it. Chances are you'll be dealing with this individual on a daily basis, often in close contact. There's a good chance you'll spend more time with your partner than with your spouse. And entrepreneurs tend to be leaders and headstrong. That person who's such a good golfing buddy can show an entirely different side in a business relationship.

The new partner should be able to carry his own weight. Don't take on a person as a partner simply because you need another employee. Ideally, he or she should bring to the business complementary strengths. For example, you have technical expertise and he has strong business or marketing abilities. In many cases taking on a partner can improve your chances of securing a loan or being recognized as a business with more management depth. The latter could prove important if you're trying to work with larger companies. (See below if you're just looking for capital.)

True partnerships can be dangerous. In a partnership (as opposed to a corporation with two or more shareholders), each partner can be held jointly and severably liable for actions of the partnerships. Thus, you can be fully liable for all partnership debts, despite the fact that you might only have a small interest in the partnership, or that you had nothing to do with incurring the debts. Clearly, you don't want a reckless or risk taking individual as a partner.

Partnership agreements and LLCs. Some of the problems with a partnership can be alleviated with a well written partnership agreement. A limited liability company (LLC) can also be used to avoid the problems mentioned above. But be careful. Failure to have an operating or partnership agreement may mean you'll be governed by the default rules of state law. Get good legal advice.

Personal responsibility in a corporation. Even in a corporation you can be personally responsible for the acts of another officer. Two of the prime examples are payroll taxes and sales taxes. But if the corporation or LLC isn't operated in a formal manner, it can lose some or all of the protection the law provides in other situations.

Consider a joint venture. While formal joint ventures are used more by large corporations, they can be attractive to a smaller business. In this case, each "partner" can be responsible for his or her own area. For example, you may manufacture the product while your joint venturer distributes it. Each of you has their own separate corporation, partnership, or LLC, and an agreement that binds the business entities. An advantage is that the joint venture agreement can be simpler than an operating agreement.

Just looking for capital? If that's your only objective, should explore other options. You could have a straight loan to the business or a loan with a feature allowing conversion of all or a part of the loan into equity capital or with a small equity investment at the time the loan is issued. Talk to your accountant or a corporate attorney for ideas.

Think about the breakup. Personal and business relationships don't last forever. It could be as ugly as a falling out among partners or as innocent as the withdrawal of a partner for health or personal reasons. Or Mike (a 50%-shareholder) and Janice get divorced and Janice gets shares of stock in the corporation. You've got a new partner. Or Mike is forced to sell his interest in the business. You want to buy his share but don't have the capital to do so. You could end up with a new partner. There are plenty of ways to handle these situations, but you've generally got to plan ahead. Again, talk to a corporate attorney and your tax adviser since there can be tax implications.

Taking on a partner or working shareholder, or even a capital contributor, can add materially to the business. But just don't rush into it. The consequences can be far reaching.

--Last Update 06/09/10