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.

By Laura Tiffany

Opinions expressed by Entrepreneur contributors are their own.

Q: My best friendand I really want to start a business together. We're thinkingof making purses to sell at boutiques around town, online and atcrafts' fairs. But people have told us that we should becareful in case our business ends up ruining our friendship. Shouldwe start a business together?

A: Many verysuccessful businesses have been started by best friends, siblingsand couples. After all, you know you get along with your potentialbusiness partner and it's easy to imagine all the funyou'll have working together. But there's a darker side tothis story, as you know. What happens when you want to grow yourbusiness larger and your friend is content with just doing it a fewhours a week? How do you plan to split the workload--and theprofits? And what happens if you guys have a fight? It's badenough when friendships go sour, but being business partners ismuch like being married--you have legal and ethical obligations toone another, and that really complicates matters.

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

  • How much of the business will each of you own? A 50/50 share isthe most obvious choice, but if your partner plans on putting intwice as much time as you, then you might want to tweak thosenumbers.
  • How will decisions be made? The voting rights of each partnerusually mirror the ownership rights, so if you're worried aboutdeadlocking with a 50/50 partner, you may want to add a third 1%partner--someone you both implicitly trust (a seasonedbusinessperson/mentor unrelated to either one of you is a goodidea) for tie-breaking decisions.
  • If one partner chooses to leave the business, how will he orshe be compensated? Not only should you decide how the businesswill be valued, but you should set up a system for payment overtime so that the partner who stays isn't hit with a balloonpayment that kills the business.

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

The next aspect of creating a partnership is legally structuringyour business as a general partnership or LLP. The structure ofyour business affects the taxes that you pay and how responsibleyou are for your business's debts. In a general partnership,the partners run the company and are responsible for thecompany's debts. A limited partnership, or LLP, has bothgeneral partners and limited partners, who are involved asinvestors only (for example, your parents) and have less liabilitythan the general partners. This form is less common and hascomplicated paperwork so you'll likely be looking intoimplementing a regular partnership. You'll want to speak to anaccountant about the tax issues of a general partnership and again,if you're under 18, you may have to include your parents on thepaperwork. It might be a good idea to consult an attorney, too, whocan draw up the partnership agreement and explain all the legalramifications to you.

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