Congratulations! You’ve found someone or a group of people you want to partner with in business. That’s great news. At the same time, you will each want to ensure you fully understand the relationship. A partnership agreement is an important document laying out responsibilities and addressing common issues that could arise. This article provides an overview of partnership agreements: what they are, why they’re needed, who uses them, and what to include when developing yours.
What is a partnership agreement?
A partnership agreement is a legal document that outlines the relationship between two or more parties (individuals or entities) that have agreed to partner. This binding document outlines each partner’s responsibilities, financial obligations, and rights and privileges.
Well-written partnership agreements not only provide a framework for the operation of the business but also help settle any conflicts that may arise. Writing down what parties have agreed to regarding divisions of profits and losses, resolution of disputes, dissolution of the partnership, and other business matters can ensure the smooth operation of the partnership.
Characteristics of a partnership
A business partnership is a business organization formed of two or more individuals or entities. Each partner will typically make a capital investment with the intention of sharing in profits and losses. Partners will also be personally liable for any debt the partnership incurs. If there is a separate legal entity from the partners, that is instead a limited liability corporation (LLC).
Partnerships also give each partner authority to make business decisions, enter contracts, and administer and control the business.
State laws govern business partnerships, with federal law playing a minimal role. As the laws will vary by region, it’s a good idea to consult a lawyer when drafting a partnership agreement.
Types of partnership
From a legal and taxation perspective, there are four main types of business partnerships. The structure you use will depend on several factors detailed in the following list:
- General partnership: In a general partnership, two or more owners share equal responsibility and rights while retaining liability for all obligations and debts.
- Limited partnership: Similar to a general partnership, a limited partnership comprises at least one or more general partners and at least one or more limited partners. The general partners bear 100% of the liability risk. The limited partners only risk their capital contributions. The limited partner also doesn’t have an active management role.
- Limited liability partnership (LLP): In an LLP, every partner has limited personal liability for business debts. This is a popular approach for larger partnerships.
- Professional limited liability partnership (PLLP): A PLLP is an LLP for licensed professionals. Accountants, lawyers, and medical professionals often need to take this route, as some states don’t allow them to form LLPs. In PLLPs, the partners must all also provide proof of licensure.
Who uses partnership agreements?
Small businesses, startups, professional services firms, investment partnerships, and other types of businesses may all use partnership agreements. The agreement establishes the foundation for that particular partnership and can reduce the risk of legal disputes in the future.
Partnership agreements are not legally required. Without one, your partnership is subject to partnership laws in your state. That could work for you, but since the laws are often standardized, there may be unintended results. Your business is unique, so you may not want to be subject to a version of the Uniform Partnership Act (or Revised Uniform Partnership Act).
What is the purpose of a partnership agreement in the contract?
The purpose of a partnership agreement in a contract is to establish the terms and conditions of the partnership and to provide a framework for the operation of the partnership.
The partnership agreement typically states the name of the partnership, outlines its business activities, delineates each business partner’s responsibilities, and details the management and decision-making structure. The agreement will also address the capital contributions of each partner, the percentage of ownership, and profit and loss allocation. Also expect procedures for admitting new partners, removing existing partners, resolving disputes among partners, and dissolving the partnership.
How is a partnership agreement different from an operating agreement?
A partnership agreement governs the relationship between partners in a general partnership, limited partnership, or limited liability partnership. An operating agreement governs the operation of an LLC. An LLC is a type of business that protects business owners from personal responsibility for business debts and liabilities.
Both documents establish clear expectations and create a shared understanding of the terms and conditions of the business entity. But each agreement is tailored to the specific needs and circumstances of the type of business.
What to include in partnership agreements
A partnership agreement is not required in all states, but it is highly recommended that you work with a lawyer to draft this important document outlining key aspects of the partnership. Use this agreement to document any oral commitments among partners. This section outlines several important provisions to consider with your partner and get in writing.
Partnership name
Clearly state the business name in the agreement. This seems obvious, but it helps to eliminate confusion if there are multiple businesses/partnerships involved.
You will also need to state the business address and location. This allows you to also specify the governing law and jurisdiction for any disputes that may arise.
Purpose of partnership
Outline the purpose of the partnership. This includes identifying the partnership’s types of business activity. In this brief overview of the business’s products and services, you’ll also put a start date for commencing the business. Many partnerships have an unspecified time frame, but if you have a length of time in mind for the partnership, specify that.
Contributions
Specify the amount of capital each partner is investing in the partnership. This includes money, assets, tangible items, property, etc., that each partner provides. You don’t want to have to worry about remembering who put in what at the beginning. Putting this in the agreement can be helpful when dividing profits and losses or in case of later disagreements.
If there are any anticipated contributions to be made as the business continues, address those requirements as well.
Responsibilities of partners
Division of work between partners is critical in joint business ventures. The agreement should state each partner’s responsibilities. There are, of course, many things to do in running a business. You may not want to record every aspect of operations and who does what. Still, recording who will handle accounting, payroll, human resources, and other critical managerial responsibilities is a good idea.
Profit & loss distribution
Establish how profits and losses will be allocated among the partners. This should also speak to when profits will be distributed and how losses will be distributed during operation and if the business is dissolved.
Expenses
Protect both the partnership and partners who want to deduct expenses by specifying in the agreement what expenses will be reimbursed by the partnership and what expenses are not paid by the partnership on behalf of the partners.
Addition or removal of partners
Many circumstances can lead to the desire to add or remove partners. Set out how new partners would be brought in, their level of authority, and how they would be paid. Do something similar for partners who leave the business. Lay out the procedures for transferring ownership of the partnership when a partner withdraws.
The agreement should also specify what will happen in case of a partner’s death. Including a buyout agreement provision can mean the difference between a business dissolving or continuing on after a partner’s passing.
Dissolution of partnership
Specify procedures for dissolving the partnership. Describe the business liquidation process and how any profits will be shared. You might also agree on a timeline and each party’s duties for the dissolution process.
Authority
Establish your decision-making structure. Typically, each partner will have the authority to make decisions and enter into contracts on behalf of the partnership. You may lay out terms regarding your decision-making process and include a voting system or another method to create a system of checks and balances.
Resolution of disputes
You’re entering into a partnership optimistic about how well you’re going to work together. You don’t want to anticipate disputes. Yet it’s better to think now about dispute resolution. You might decide to resolve disputes using a predetermined mediator or your business advisory board. Make a choice and put it in writing.
Next steps
Partnership agreements are important documents outlining the key provisions of the partnerships and governing their operation. This article has outlined many essential elements to help you and your partner or partners navigate doing business together.
Before crafting your partnership agreement, you’ll need to be sure you fully understand the types of partnerships. Review our overview article or dive right into our detailed discussion of family-limited partnerships.