Forming a partnership

What is a Partnership

A partnership is a business arrangement in which two or more people own an entity, and personally share in its profits, losses, and risks. The exact form of partnership used can give some protection to the partners. A partnership can be formed by a verbal agreement, with no documentation of the arrangement at all.

How to Form a Partnership

The main steps involved in forming a partnership are as follows:

  1. Select a name for the partnership

  2. Register the trade name for the partnership

  3. Create and sign a partnership agreement

  4. Obtain tax licenses and other operating licenses as needed

  5. Obtain all relevant types of business insurance. This should include the following types of insurance:

    • General business insurance

      • General liability insurance. Covers third-party claims for bodily injury, property damage, and legal expenses.

      • Commercial property insurance. Protects business property, equipment, and inventory from theft, fire, or disasters.

      • Business interruption insurance. Provides financial support if the business is forced to close temporarily due to a covered event (e.g., fire, natural disaster).

    • Partnership-specific insurance

      • Partnership life insurance. Ensures financial stability if a partner passes away; the payout can be used to buy out the deceased partner’s share.

      • Key person insurance. Covers financial losses if a critical partner becomes disabled or passes away.

      • Buy-sell agreement insurance. Funds the buyout of a partner’s share in case of death, disability, or retirement.

    • Employee-related insurance

      • Workers’ compensation insurance. Covers medical expenses and lost wages for employees injured on the job (required in most states).

      • Group health insurance. Provides medical coverage for employees and partners.

      • Employment practices liability insurance. Protects against employee-related claims like wrongful termination, discrimination, or harassment.

    • Professional insurance

      • Professional liability insurance. Protects businesses offering professional services (law firms, accounting firms, consultants) from negligence claims.

      • Product liability insurance. Covers claims related to defective products that cause harm.

      • Cyber liability insurance. Protects against cyber threats like data breaches and hacking.

The Partnership Agreement

When a verbal partnership agreement is used, there may be subsequent disagreements among the owners at a later date regarding what was originally agreed to. Consequently, it makes sense to create a written document that states how certain situations are to be handled. This partnership agreement should at least cover the following topics:

  • The rights and responsibilities of each partner

  • Whether partners are designated as general partners or limited partners, since this impacts their responsibility for the liabilities of the partnership

  • The proportions of partnership gains and losses to be apportioned to each partner

  • Procedures related to the withdrawal of funds from the partnership, as well as any limitations on these withdrawals

  • How key decisions are to be resolved

  • Provisions regarding how to add and terminate partners

  • What happens to partnership interests if a partner dies

  • What steps to follow to dissolve the partnership

  • The proportions of residual cash paid out to the partners in a liquidation

Related AccountingTools Courses

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Partnership Tax Guide

Additional Partnership Formation Activities

In addition to the partnership agreement, the partners must engage in a number of other formation activities that are common to all types of businesses. These actions include:

  • Register the business name

  • Obtain an employer identification number

  • Obtain any licenses required by governments where the partnership plans to operate, such as a sales tax license

  • Open a bank account in the name of the partnership

  • File an annual informational return with the Internal Revenue Service

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