Lets say that you are a superb artist that specializes in pastel paintings. You have a friend that is an artist that specializes in acrylic paintings.
The two of you have been friends for most of your life, and have equally admired each other's work. You admire each other's work so much, that one day both of you at the same time recommend that the other should start painting for a living! Everyone needs good art, why not sell your art? The walls of houses, schools, and offices are always in need of trinkets and paintings to give them life.
After starting your individual companies, and beginning to see some success, you one day decide that you should create a business together. Two brushes are better than one you say, why not go in together? But how? How do you go into business with someone? What are your options?
Generally, there are two different routes you can take to go into business together. You can establish a partnership or an LLC (limited liability company). There are both advantages and disadvantages to each.
What is a Partnership?
A partnership is an agreement between two entities to create a business and share, in some respect, the revenues, expenses, and responsibilities of that business. The key phrase is sharing responsibilities. This means that if the company goes under, the partners are liable for all the company’s debts. If the company borrows $250,000 in year one and in year two go bankrupt then the partners are responsible for paying that debt. This means that their personal assets—home, car, beach house, etc—are at risk of being sold to pay the debts.
Another negative about a partnership is its ability to raise capital, or money. The partners are responsible for raising capital and not anyone else, such as a shareholder in a corporation. This means that they can only contribute to the extent that they have free cash available.
The main benefit of a partnership is that a partnership is relatively easy to set up and get running. The costs are low and the their aren’t as many hoops to jump through in terms of paperwork and legal filings. Partnerships are also advantageous because the accounting and bookkeeping is not as strict.
What is an LLC?
LLC stands for Limited Liability Company. A limited liability is essentially a hybrid company between a partnership and a corporation. It shares characteristics of both, and for this reason it is a very popular form of business. There are three main advantages of an LLC. First, the owners are not personally liable for the company’s debt. If an LLC runs out of funds, the owners do not have to worry that their house will be put on the market. Second, it is easier for an LLC to raise money. It is similar to a corporation in that it can raise money by issuing stock, or a share of ownership in the LLC. These shareholders are also not liable for the company’s debts. The third benefit of an LLC is that ownership is easily transferred. It is difficult for a partner in a partnership to sell his share of the company. It is much easier to sell ownership in an LLC.
The disadvantages of an LLC are that it can be costly to set up, and there are more requirements for paperwork and legal filings. The accounting is also a bit more stringent. You have to make sure to separate business income from personal income. Usually a separate tax form is required when filing yearly tax returns with the IRS.
So, back to our original example, if you want to go into business with your friend doing paintings, it would be wiser to establish a partnership. This is mainly because it is easier to set up, and you’re not in need of raising capital. You won’t have much debt, so you don’t have to worry about being personally liable for any debt you assume. In this case, a partnership makes the most sense!
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