Partnership formation questions explained with examples

The distinctive thing about partnership questions is that the arrangement can already exist before anybody asks one. Two people who work together and share the proceeds are usually in a partnership under their state's default rules, whether or not they filed anything, named it, or intended it.

So the first question is never "should we form a partnership?" It is "what are we already in, and does what we agreed match it?"

What to take away

• The default rules are running now. Nothing has to be signed for them to apply, and they decide the questions nobody wants to think about.
• Every question about what happens on a fallout, a death or an exit is answered somewhere already. The only choice is whether it is answered by your agreement or by the default.
• Which specific defaults apply is a state question and a lawyer's question. This page states none of them.
• A written agreement is worth most when relations are good, which is the only time everyone can agree on what is fair.

What are we already in?

If two or more people carry on a business together and share what it makes, most states will treat that as a partnership without a filing. That has consequences immediately: about who can commit the business, about who is answerable for what, and about what happens when one of you wants out.

Ask a lawyer what your state's default arrangement actually says, in your situation. It is a short question with a specific answer, and it is the one that tells you which documents you cannot skip. The IRS keeps its own description of how it treats a partnership for federal purposes, which is a separate matter from the state law question and worth reading alongside it.

Questions to answer before anything else

These have no correct answer. They have your answer, and writing it down is the point.

• Who contributed what: money, equipment, customers, work, a name, credit?
• Is the profit split the same as the ownership split, and if not, why not?
• Who decides what, and which decisions need everyone?
• Who may sign a contract that binds all of you?
• What happens to a share on death, illness, or someone simply wanting out?
• How is that share valued, by whom, and paid over what period?
• What happens if one of you stops contributing but keeps drawing?
• How does the arrangement end, and who gets what when it does?

Six of those eight are about exits. That is not pessimism. Exits are where partnerships actually fail, and they are the part nobody wants to discuss at the start, which is exactly why the discussion belongs at the start.

Questions for a lawyer

• What does our state's default arrangement say about each of the eight questions above?
• What exposure does each of us carry for the acts of the other, and does that change under a different form?
• Does anything we have already signed bind all of us?
• If we want a form with a separation, what are our options and what do they cost to run? That comparison begins in choosing a structure, and the mechanics of one common answer are in forming an LLC.
• What do we need to do to make the agreement enforceable, and does anything have to be filed?

Questions for an accountant

• How is what we take out treated, and does the split we agreed work the way we think?
• What has to be filed, by whom, and when?
• If one of us contributes property instead of cash, what does that do?
• What changes if we later bring in a third person?

These are not questions to solve between yourselves with a spreadsheet. The interaction between how profit is allocated and how it is taxed is where general advice goes wrong most often.

Questions of record

Some things are simply matters of record, and the office that holds the record is the only source. Whether a name filing is needed for the name you trade under, what licenses your activity requires, and whether the arrangement needs a federal identifier of its own. The last of those is the clearest: an arrangement with more than one owner generally does, for the reasons set out in the federal identifier, and the IRS issues it at no charge through its own application process. The name question is covered in trading under a name.

The question that gets skipped

What happens if we simply disagree, and neither of us will move? Without a mechanism, the answer is a stalemate that only a court can break, and by then the business has usually stopped working. An agreement that names a way out of a deadlock, whatever way you choose, is worth more than most of the clauses people argue about.

Common questions

Do we have to file anything to be a partnership?

Often not, which is the difficulty. The arrangement can arise from conduct, so the absence of paperwork is not evidence that nothing exists.

Is a handshake agreement enough?

It is an agreement, and it is unprovable. Every question in the list above becomes a memory contest. Writing it down is a few hours and it is the cheapest insurance in the subject.

Can we write the agreement ourselves?

You should write the answers yourselves, because they are your answers. Turning them into an enforceable document, and checking them against your state's defaults, is what the lawyer is for.

What if we already have been operating for two years?

Then write it now and be explicit about what you are recording versus what you are changing. The conversation is harder than it would have been, and it is much easier than it will be later.

What if one of us wants an entity and the other does not?

That disagreement is usually about maintenance rather than about protection. Price the actual recurring work of the alternative, and the argument tends to resolve itself.

What changes when the arrangement changes?

Ownership, address and contact details all sit in records that have to be kept current, which is the subject of keeping records up to date.