Transitioning from a sole proprietorship to a partnership is necessary when more than one person becomes involved in a formal business setup. And while setting up a partnership may be slightly more complicated than establishing a sole proprietorship (business owned and run by only one person), it’s still a relatively easy and inexpensive process.
As only one person is involved in a sole proprietorship, it isn’t typically established by a formal business agreement. For this reason, U.S. legal guidelines don’t require the official dissolution of a sole proprietorship before a partnership can be formed.
If the time has come to change your business structure, the following steps will make the transition smoother:
Step 1: Decision Time
Many people mistakenly regard the setting up of a partnership agreement as the first step in transitioning from a sole proprietorship to a partnership. The correct starting point is to decide which type of partnership will be best suited to your organization. The business activities, resources available to the various intended partners, and each person’s contributions and decision-making powers will all need to be considered.
Most U.S. states allow for the establishment of three types of partnerships. These are:
- General Partnerships
- Limited Partnerships
- Limited Liability Partnerships
Determining which of the three structures to form will depend on the type of business and the dynamic among the intended members.
The main difference between the three types of partnerships is a balance of control vs. liability. An explanatory overview of each type of partnership highlights the differences in each case:
- The general partnership: This type of partnership is where each partner assumes full personal liability for the entity’s debts. Even though the agreement will ultimately determine the division of ownership and profits, future debtors will be at liberty to collect monies owed to them from any or all of the partners registered.
- The limited partnership: In the case of a limited partnership, one partner will be nominated as fully liable for the partnership’s future debts and liabilities. All other partners will have limited liability. The partner registered as having unlimited liability will typically be the individual who has the final say in all management decisions.
- The limited liability partnership: the limited liability partnership (LLP) limits each partner’s liability proportionate to the amount invested in the business when forming the LLP.
Step 2: The Agreement
Once the intended parties agree on which type of partnership will best suit their organization, it’s time to draw up the Partnership Agreement.
The Partnership Agreement will contain a description of every intended member's contributions and responsibilities and an explanation of certain actions and consequences. Some or all of the following will be covered:
- The amount of capital and/or other contributions and resources to be made by each intended partner.
- An apportionment of partnership income or loss.
- Each intended partner’s responsibilities – who will be responsible for the day-to-day running of the business.
- The conditions under which a partner can decide to sell their interest/s in the business.
- The conditions that will apply in the event of the taking apart (dissolution) of the intended partnership.
- Those conditions applicable to the settling of disputes.
Step 3: Decide On A Name
The name of the partnership will typically reflect the type of business conducted by the partnership. Once a name has been decided on, it needs to be registered with the state where the company will be performing its operations.
Registration of a partnership can generally be completed online at each U.S. state’s Secretary of State website.
If a partnership will be conducting business in more than one state, it becomes necessary to complete a separate registration process for each relevant state. The “main” state will be listed as domestic, and the remaining states as foreign.
Along with the partnership’s registered name (to be approved and/or guided by the relevant state’s online system), the general rule is that a fictitious name will also be filed. This is commonly referred to as a DBA – short for Doing Business As.
Step 4: Employer ID Number
Once all of the above steps have been duly completed, the next step is to register the partnership with the U.S. government’s Internal Revenue Service (IRS).
Registering a partnership with the IRS is a typically straightforward, hassle-free process and can be done online. It is important to be aware that the IRS will never charge a fee for applying for what is referred to as an Employer ID Number (EIN).
If a site requests a fee in return for an EIN, that site can automatically be considered fake and must be reported to the IRS.
Step 5: Licenses And Permits
The fifth and final step will depend on the type of business the partnership intends to conduct. These details can be included in your business plan, and this will provide the blueprint for the way forward here.
Examples of additional steps to be followed include:
- If products and services will be sold, it becomes necessary to first register for sales taxes. This should be done with the individual state’s taxing authority.
- If the partnership intends to employ staff (employees), the partnership must register for federal taxes (on behalf of future employees). This registration is also done online – and via each state’s EFTPS payment system (available via a simple online search).
- Last but not least, and again depending on the type of business, said organization will have to apply for the licenses and/or permits relevant to future business activities.
These five steps clearly outline the actions needed to complete the transition process. If you or your future partners are in doubt at any stage, it’s best to seek expert advice before proceeding further.
Kristie Wright is an experienced freelance writer, where she covers topics on finance and business, often catering to small businesses and sole proprietors. When she’s not typing away at her keyboard, Kristie enjoys roasting her own coffee and is an avid tabletop gamer.
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