Fact checked for accuracy by Billie Anne Grigg, a bookkeeper and Mastery Level Certified Profit First Professional.
Entering into a partnership is a significant step for a business owner. A partnership allows the entering parties to share capital, resources, knowledge, and clients, among other things. It may also signal that a business is entering a new stage, ripe with expanded possibilities and new prospects.
If you’re considering establishing a business partnership, you’re likely anticipating that everyone involved is coming in with similar goals and will work cohesively as a team.
While this is a fair assumption, it’s still a good idea to discuss operational expectations, terms, and liability upfront – and an even better idea to solidify these discussions into a written partnership agreement.
A partnership agreement is not a legal requirement for forming a partnership, but creating one early on will protect both parties in the event of a disagreement later on. It will also make resolving disputes easier by providing an agreed-upon set of operational guidelines.
Read on to find out what goes in a partnership agreement, why they are important, and where you can find partnership agreement templates online.
What to Include in a Partnership Agreement
Each partnership agreement will be different depending on the business and how many people are involved. At its most basic, a partnership agreement should include the following:
Identifying Information for Both Parties and the Business
This first section should include the full names of each partner, and the name, address, and purpose of the business. You should also have the start date and the expected length of the life of the partnership.
The Type of Partnership
There are three main types of business partnership:
- General Partnership (GP)
- This is the most basic form of partnership. It offers no personal liability protection and you are not usually required to register with the state. Each partner has equal power and equal liability.
- Limited Partnership (LP)
- One partner – the general partner – is responsible for the business. The other partner – the limited partner – might provide capital but has little decision-making ability and limited liability.
- Limited Liability Partnership (LLP)
- This operates as a general partnership but provides liability protection for each partner from the other’s actions. Neither partner is held personally responsible for the business’s debts or the other partner(s)’ actions.
In addition to the three main types, some states also recognize the Limited Liability Limited Partnership (LLLP), a limited partnership where both partners are considered general partners and are shielded from personal liability. A Limited Liability Corporation (LLC) with at least two members is also considered a type of business partnership.
You should draft a partnership agreement regardless of the type of partnership you’re entering into – even a general partnership not registered with the state. It’s important to include the kind of partnership in the agreement because the regulations for each type are different. If you have a limited partnership, indicate which partner is the general partner and the limited partner.
Contributions Made by Each Partner
List the initial capital that each partner will contribute to the partnership. Capital includes physical assets like property or resources, current employees, existing client relationships, financial contributions, and intellectual property like inventions, ideas, or even slogans and branding. You should state the value of each asset and what will happen to the property in the event of dissolution or other changes to the partnership.
Compensation and Liability of Each Partner
Clearly state how you will compensate each partner. How will you distribute property, gains, and losses? For what is each partner responsible? Liability will largely depend on the type of partnership you have: in a general partnership, for example, each partner is considered personally liable for the business’s debts. However, partners can decide amongst themselves how to divvy up fiscal responsibility.
Control and Voting Rights
Establish early on what percentage of the company each partner controls. Establish who has the power to make business decisions. It’s not required for a partnership to establish a board of directors, but it’s good practice to create a meeting schedule upfront. Use that time to vote on any issues that may arise. It’s best for partnerships between two individuals to avoid a 50/50 voting split because this will frequently result in a stalemate. Establish how to split the vote.
Changes in Partners
Include a proviso for what should happen if one partner wants to leave the partnership or how new partners can join. Set up procedures for what will happen should one or both partners die or retire. Outgoing partners are often entitled to a return of their initial capital, so state which portion of the initial capital belongs to which partner. Incoming partners might be subject to approval by vote or required to make a minimum contribution before coming on board, so be sure to include those items too.
Any agreement or contract entered into should include a proviso about how the contract might be revised or amended in the future. A business partnership is an ever-changing and evolving relationship, so the contract should be flexible enough to accommodate those changes.
Other Specifics Unique to Your Partnership
Every business partnership is different, and the sections listed above might not cover every aspect of your particular situation. If there are other business features that you need to account for, include a section detailing those.
Where to Get a Partnership Agreement Template
Drafting a legally-binding document can feel like a daunting task, and it’s not something you want to do without guidance. Fortunately, many online resources provide partnership agreement templates.
Why Partnership Agreements are Important
A partnership agreement protects both partners in the event of a conflict. When terms are written down, there is no chance of either party taking advantage of the other or changing the terms to create a more favorable outcome for themselves. It’s much easier to resolve conflict when following an established precedent. A partnership agreement may also prevent friction from arising in the first place.
Another important reason for creating a partnership agreement is to replace the state’s default rules for governing businesses. A written agreement gives owners more control over what happens to their business when situations arise that the state might resolve unfavorably by default.
What Happens If There Is No Partnership Agreement
You are not legally required to write a partnership agreement. However, if an issue arises between the partners and there is no partnership agreement, the state you are in will resolve disputes according to its default laws for business. In many cases, these laws might resolve issues in a way that is unfavorable to one or both parties. Frequently, state laws are not sufficient to handle nuance, and many are outdated.
Businesses that do not have a written partnership agreement may also be subject to unexpected tax liability. Tax laws regarding partnerships were considerably revised in 2017, such that the partnerships themselves (rather than the participating partners) are responsible for all taxes attributable to the partnership’s income. Partners can elect to opt-out of the new laws under certain circumstances. This is where it’s important to have a written partnership agreement that outlines each partner’s liability.
The Last Word
A partnership agreement is a vital document to create when forming a new partnership. Have more questions? Send us a note.
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Filed under: Advice Columns