Before you go into business with someone, you'll need a partnership agreement in place.
The Business.com Community often asks about the ins and outs of partnership agreements. We dug in to find out what you need to know to create your own agreement.
How to create a partnership agreement
Partnership agreements are an important part of going into business with one or more people. A partnership agreement is a document that you and your partner create to clearly lay out the duties of each partner, each partner's liabilities, and the percentage of profits each partner is entitled to, among other aspects of creating a business together.
While not all partnership agreements are laid out in the same way, there are elements that should always be included.
Name of the partnership
A partnership agreement is a legal document, and like any other legal document, partnership agreements have certain rules and stipulations. Though partnership agreements vary depending on the type of partnership, there are some aspects of the arrangement that should be clearly laid out.
The name of the partnership should be registered with the county clerk's office to ensure availability of the name. Once the name is secured and registered, all documents having to do with the partnership should use this name.
Capital, investment, and profit or losses
Investors in your business need to specify just what exactly they have invested in the partnership. "A written partnership agreement would be important if you wanted to detail an understanding of how much and what type of capital will be offered to the partnership," says Mike Gallagher, district director of the SBA North Dakota District Office.
The distributive share or percentage that each partner receives from the partnership should be the same as that of their investments.
"Draws from the partnership are a reduction in the capital provided by individual partners. Partners do not get a "wage" or "salary." Any money they take out of the business in the form of cash or other assets is a draw or reduction in the capital basis. Detailing how much each partner can draw from the business would be another important element to include in the partnership agreement," Gallagher said.
Not all businesses earn a profit every year, especially when they are just getting started. The partnership agreement should also specify how much yearly business loss each partner is responsible for absorbing. In most cases, it is illegal to assign more loss to partners who did not originally invest in the company, and losses (like profits) should be determined by the percentage that each partner has invested.
Specific language should be used in a partnership agreement to define each partner's roles. This prevents the company from being forced into an agreement by a partner who is not authorized to form such agreements without consent.
The general partner in a limited partnership (a partnership with both a general partner and a limited partner or partners) is the person responsible for day-to-day business transactions and decisions. The general partner is liable for debts and liabilities within the business.
Limited partners, also referred to as "silent partners," do not have a say in how the business is managed; they simply invest money in the partnership and receive their share of the profits. In the case of a limited-liability partnership, there are no general partners, which means all partners have limited personal liability when it comes to business debts.
If the positions of the partners are not clearly defined in the partnership agreement, there could be problems with silent partners wanting to make business decisions that exceed their authority.
You and your partner may not always agree on what to do, resulting in a dispute. If you have an odd number of partners, a simple vote may determine a course of action. In the worst-case scenario, partners might find themselves on opposing sides in court, which costs a lot of time and money.
"My recommendation is to include a mediation clause in your partnership agreement to provide a procedure by which you can resolve major conflicts," says Susan Solovic, CEO and founder of ItsYourBiz.com. A mediation clause can often resolve many disputes and repair working relationships.
Unless otherwise stated in the partnership agreement, the shares of one partner go to the remaining partner(s) upon his or her death. In some states, the shares could go to a surviving spouse, which may complicate how the business is run. It is best to come to an understanding and include it in the partnership agreement, as well as in each individual's personal estate documents, to ensure continuity of the company.