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How Should I Protect My New Partnership?

You may have been best friends forever, but you should still protect yourself legally when you're starting a business with a friend.

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Q: My best friend and I really want to start a business together. We're thinking of making purses to sell at boutiques around town, online and at crafts' fairs. But people have told us that we should be careful in case our business ends up ruining our friendship. Should we start a business together?

A: Many very successful businesses have been started by best friends, siblings and couples. After all, you know you get along with your potential business partner and it's easy to imagine all the fun you'll have working together. But there's a darker side to this story, as you know. What happens when you want to grow your business larger and your friend is content with just doing it a few hours a week? How do you plan to split the workload--and the profits? And what happens if you guys have a fight? It's bad enough when friendships go sour, but being business partners is much like being married--you have legal and ethical obligations to one another, and that really complicates matters.

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The first thing you'll want to do when starting a business with a friend is imagine the worst-case scenarios and then prepare for them by drafting a partnership agreement. Some items you'll want to cover in this agreement include:

  • How much of the business will each of you own? A 50/50 share is the most obvious choice, but if your partner plans on putting in twice as much time as you, then you might want to tweak those numbers.
  • How will decisions be made? The voting rights of each partner usually mirror the ownership rights, so if you're worried about deadlocking with a 50/50 partner, you may want to add a third 1% partner--someone you both implicitly trust (a seasoned businessperson/mentor unrelated to either one of you is a good idea) for tie-breaking decisions.
  • If one partner chooses to leave the business, how will he or she be compensated? Not only should you decide how the business will be valued, but you should set up a system for payment over time so that the partner who stays isn't hit with a balloon payment that kills the business.

If you're under 18, your parents may have to co-sign to make this agreement legally binding. Consult an attorney to find out the laws in your state and to make sure your agreement is legally sound.

The next aspect of creating a partnership is legally structuring your business as a general partnership or LLP. The structure of your business affects the taxes that you pay and how responsible you are for your business's debts. In a general partnership, the partners run the company and are responsible for the company's debts. A limited partnership, or LLP, has both general partners and limited partners, who are involved as investors only (for example, your parents) and have less liability than the general partners. This form is less common and has complicated paperwork so you'll likely be looking into implementing a regular partnership. You'll want to speak to an accountant about the tax issues of a general partnership and again, if you're under 18, you may have to include your parents on the paperwork. It might be a good idea to consult an attorney, too, who can draw up the partnership agreement and explain all the legal ramifications to you.