Kathryn McCall covers moving from solo work to partnerships: why written agreements matter, how to split profits and ownership, and what happens if someone wants out. She also explains LLCs, which shield owners from personal liability while letting profits pass through to their tax returns.
Chapters
So, what's the next level kind of if you're thinking about moving from the simplest form which is a sole proprietorship to a little more complex? It's a partnership. Sole proprietorship, one person. Partnership, 2 people. 2 people come together and say, let's do a business together. Boom, you're a partnership. Yes? Is it easy to make that change? In the middle of the way?
Yeah.
I mean, compared to the stage of— Yes. You can make that change anytime along the way. The farther along your business is, the more documentation you might need in order to make that change. But it's easy to do. I mean, it's not impossible. And as long as you've— we get back to recordkeeping— as long as you've kept Records about what is it that the business owns and the taxes and the finances and all so that when you take, say, your sole proprietorship and maybe transition it to a corporation, you know what assets you're going to take and what that business— what needs to be transferred into that corporation. But yeah, at any stage, I mean, a lot of you guys, if you have a business idea right now, you're a sole proprietorship. And then you can become a corporation. It's easy to do. And if you're working with one other person, you're in a partnership because the two of you are working together. A partnership— I mean, I'm in a law partnership. I have 29 partners. Believe me, some days it's not so easy with 29 people. But so— but a partnership is 2 people, 3 people. Anytime you're more than one, but you haven't formed a legal standalone entity, you're a partnership. So the business is owned by the partners, so several individuals, the partners. Each partner contributes to the business and also pulls money out of the business. So each partner brings a skill set to the business— money, property, labor, skill, whatever it is that they have. Each partner shares in the profits and losses. of the business, and each partner is personally liable for the partnership's debts and liabilities. And then again, the profits and losses pass through the partnership and are reported on each of the individual partners' income tax returns. So how do you form a partnership? It's as easy as, hey, Bob, let's start a business together.
Okay.
You're done. Partnership. That's a partnership. It's really easy to form. Although it's not required, you don't need any sort of formal written agreement. However, if you're working with anybody, I really— I suggest you put some sort of agreement together. It can be bullet points on a piece of paper that you both sign. Just something so that you agree what are our responsibilities and roles. What am I going to do? What's my partner going to do? Make sure we each understand what we're bringing to the partnership and what our responsibilities are. How are we going to distribute the profits? How are we going to distribute the losses? What if we get into a dispute? How are we going to resolve that? It's much easier to decide how to resolve a dispute in the beginning when you're really excited about this fabulous idea that you have than it is a year into it, you're You're struggling, it's hard, it's difficult, you've hit some roadblocks. Now you've got a dispute, everybody's tense and upset, and now you've got to figure out how to resolve it. It'd be really nice in that situation if you were able to say, here's our partnership agreement and we agreed this is how we would resolve a dispute. We're going to go to mediation at this place. If that doesn't work, we're going to go to arbitration. It immediately can defuse the situation because now you have a road path, a roadmap of what you're going to do. Otherwise, then the dispute might be how you're going to resolve the dispute. And that can take a while to figure out how you're going to resolve the dispute. And then everybody says, okay, now we figured out how to resolve the dispute. What was the dispute? So figure out those things in the beginning and figure out also changes in ownership. What's going to happen if you— So say you've got 5 people. One person wants to leave. What's going to happen when that person leaves? Are the other 4 people going to buy that person out? Is the partnership going to buy that person out? How is that going to happen? What is that going to look like? Question? Nope? Okay. So now— yes?
So on the partnership one, if it's just you and somebody else, Someone else, but one person is doing a lot more of the main work and you start to bring on other people. How would you say you should start to split off that? Like if I had somebody doing 30%— Sure.
You talk about it with your partners. And you say— which is, again, why it's really important to have those conversations in the beginning and say, hey, these are my responsibilities. These are my roles. This is what I'm going to be doing. I'm going to be taking the leadership role. Therefore, I think I should get a 60% ownership of this business and take 60% of the profits, 60% of the losses. You 2 over here are going to be doing— have a lesser role. So, you each get 20%. That gets us to our 100%. But those are the discussions you need and they're hard discussions to have But they never get any easier. And they're so much easier to have in the beginning when everybody's excited and you haven't really put your blood, sweat, and tears into it yet. Have those discussions in the beginning. Sometimes it happens really naturally. You kind of figure out, this is the guy. It was his idea. He's the leader. I'm the developer. It sort of falls naturally into place. Other times you're sitting there and you're shocked to find out that your business partner thought they were the leader. They were going to be the head person. And that they just thought that you were this little minor role, a little helper that was just helping them along. So again, it's important to have those conversations in the beginning. I mean, I would say your first thing is, hey, Bob, let's work together. OK. How much are you going to own? What am I going to do? What are you going to do? That's your next conversation is what are we each going to do for this before you start really putting effort, work, and money into it. Have those conversations because it's a lot easier in the beginning to do that.
OK.
So now we've got the limited liability corporation. Or company, LLC. This is a hybrid entity that combines partnership aspects and corporation aspects. You have— so I've talked about limited liability of a business entity. Does everybody understand what that is or what that means?
Yes.
What it means is essentially you have a business. If that business has losses, If that business gets sued, the business is liable, but the owners of the business are not, as long as they maintain certain formalities and follow certain procedures. So the liability stops at the business level. So if you've got a startup, you've taken in a lot of money from outside investors, and it goes under, you personally are not liable. The startup, the company is liable. So that's what we start talking about limited liability features or the limited liability of a corporation or a partnership— or sorry, a corporation or an LLC. Is it the company, the LLC, the corporation is liable for its debts and liabilities? The owners are not. But with the LLC, the profits and losses of the LLC flow through to the member's income tax return, just like a partnership or a sole proprietorship. So that's why the LLC combines aspects of a corporation and a partnership.
