If you are entering a business partnership, it's important to understand the rules of a partnership agreement and how to create one. Here's what you need to know about partnership agreements.
If you plan on going into business with a partner, a written partnership agreement is a crucial document to protect both of you. A partnership agreement spells out the rights and responsibilities of each business partner and helps you avoid future conflict. Without this document, minor misunderstandings can erupt into major disputes, which can be devastating to your business.
What is a partnership agreement?
If you are forming a business partnership, such as a limited partnership or limited liability partnership, it's best practice to have a partnership agreement in place. A partnership agreement is a document that you and your partner(s) create to clearly lay out each partner's duties and liabilities, the percentage of profits each is entitled to, and other aspects of creating a business together.
What is the importance of a partnership agreement?
Even if you're going into business with a family member or close friend, a partnership agreement can help you avoid conflict or future legal difficulties. Common problems that arise in partnerships include the division of ownership, roles and responsibilities, and the division of assets in a termination of the partnership. A partnership agreement can protect you and your partners in all these areas, but it can also prevent minor misunderstandings from happening in the first place.
How to create a partnership agreement
Every state has its own laws concerning partnerships in the Uniform Partnership Act, also known as the Revised Uniform Partnership Act. Before you create a partnership agreement, make sure you and your partner(s) are familiar with your state's laws, as the statutes defined under the UPA will control many aspects of your partnership, unless you determine different rules within a written agreement.
State laws regarding partnerships are designed to be broad and won't necessarily apply to your needs and circumstances. Depending on your business, your state's UPA may not be helpful for your specific situation. A partnership agreement, on the other hand, can and should be as specific and detailed as possible.
While not all partnership agreements are laid out in the same way, they should always include the following elements.
Name of the partnership
You should register the name of the partnership with your county clerk's office to ensure availability of the name. Once the name is secured and registered, all documents pertaining to the partnership should use this name.
Capital, investments, and profits and losses
Investors in your business need to specify exactly what 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," said Mike Gallagher, former 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," Gallagher said. "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."
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.
A partnership agreement should use clear, specific language to define each partner's role. 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 responsible 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 agreement does not clearly define the partners' positions, there could be problems with silent partners wanting to make business decisions that exceed their authority.
Resolution of disputes
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," said Susan Solovic, serial entrepreneur and bestselling author of It's Your Biz. A mediation clause can often resolve 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 early on and include it in the partnership agreement, as well as in each partner's personal estate documents, to ensure continuity of the company.
Partnership agreement examples
There are plenty of online resources to help you write or structure your partnership agreement. Many websites offer a free template to get your partnership off the ground. These four companies provide free examples and templates you can use to build your partnership agreement:
Marci Martin contributed to the reporting and writing in this article. Some source interviews were conducted for a previous version of this article.