Before you collaborate with another business entity, you must learn how to write a partnership agreement.
A partnership agreement is a binding legal document that defines how the business partnership and legal entity are managed.
It details the partners, assets, profit shares, and liabilities.
It is drafted to define clear expectations and define rules on how to run the business and may come in handy in case of any disagreements.
A partnership agreement is also commonly known as:
- Business Partnership Agreement
- General Partnership Agreement
- Partnership Contract
In essence, a partnership agreement lays the ground rules defining the structure of the relationship between partners. That is, in the best interests of the business.
It’s where the role of each partner is defined, including the stakes in the business in terms of profits and losses.
The responsibilities of each partner are clearly laid out and guidelines on decision making. And what to do to end the partnership is also included.
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Laws Governing Partnership Agreements
When creating a partnership, you must understand the jurisdiction in which the partnership is made.
That’s because it may have to be enforced by a court of law in case of a breach.
In the US, the state laws generally guide the creation, organization, and dissolution of partnerships.
Each state may have its own laws. Though all states except Louisiana have adopted the Uniform Partnership Act (UPA).
The UPA determines the basic rules and outlines how a partnership engages unless the partners set up their own rules.
Partnership agreements can either be written or unwritten and can also be implied or expressed due to various legal issues.
In case of the unwritten and implied agreements the courts often have to gauge the:
- Partner intent
- Profit loss sharing
- The capital investment of each partner
- Common ownership of property
A written agreement often takes away the hassle, lawyers, lawsuits, and the confusion of who owns what when things go sour.
There are very few federal laws that actually guide the management of and drafting of partnership agreements.
Since partnerships are not taxed entities, the parties must understand that they have a tax liability depending on the share of the company’s profits.
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A custom partnership agreement is more effective than following state rules.
That’s because the state laws are often a one size fits all law that may not work for your particular situation.
Knowing the rudiments of how to write a partnership agreement could come in handy when you’re trying to raise funding for your company.
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The Importance of Partnership Agreements
You shouldn’t ignore the importance of creating a partnership agreement. Here are some key benefits you can expect from creating one:’
Laying Out The Rules
As mentioned above, all partnership agreements are governed by state and federal laws in the absence of a contract.
The fact that the law is standard means that it may not work for your situation.
Having a written agreement gives any partner the liberty to vary rules and be more specific depending on the need of the business.
Control Over Ownership
A great partnership agreement sets reasonable limits on the sale and transfer of interest subject to the partner’s agreements.
Working with an unwritten agreement puts you at risk as a partner can sell the ownership of a business to anyone without notice. And, that includes a competitor.
An agreement helps to set out rules on what to do in extreme conditions.
Like, for instance, the death or disability of a partner and on who takes over in the absence of them.
Having control over who it can be sold to and when can help bring stability and improve business success.
All businesses face uncertainties. A partnership agreement is a great tool to sort out some decisions ahead of time serving as a great dispute resolution tool.
The agreement can specify who handles disputes and the type of dispute resolution strategy that works for them.
The lack of an agreement makes it difficult to handle disputes through arbitration or mediation.
By having a partnership agreement in place, you can help reduce the cost of expensive litigation and legal proceedings.
A business environment is challenging.
A business partner with the best of intentions can turn rogue due to a small disagreement and threaten to sink the business.
It is a very common problem especially with partners who contribute skill rather than money in a business.
Even the most serious of partners can get demotivated by lofty profit ambitions not being met.
Unmotivated partners may choose to work for the competition threatening to sink the business altogether.
Lack of an agreement stating how to handle such issues implies that you either have a lengthy court process to attend to.
Or simply watch the business go down the drain.
A business agreement can help highlight the prerequisite conditions for a non-performing partner.
And how to kick them out and recover their assets to keep the business afloat.
Secure Business and Partner Investments
Every business must have assets or cash to operate.
The different investments may be owned by the business or by particular partners at an agreed proportion.
General partnerships are generally very risky as the partnership can end on the death, bankruptcy, or disability of a partner.
A partnership agreement can help highlight such events and help insulate the business and the owner’s assets when anything unexpected happens.
Partners are privy to confidential business information and should have confidentiality and non-compete provisions in the agreement.
This factor prevents losses due to reckless partners.
Protect Both Majority and Minority Owners
Both minority and majority owners have an interest in the business that must be protected at the creation of the partnership.
The interest becomes apparent when either the minority or majority owner wants to sell out their ownership to a third party.
It’s only fair that each owner has knowledge of the sale and isn’t damaged by future investments and transfers of interest.
The interest of the minority must be fully protected from an unwanted new third-party owner who may change company policy on whims.
The interest of both the majority and minority can be safeguarded using “tag-along” and “drag along “clauses.
These are essential to ensure that each owner is at no disadvantage from the action of the other.
When understanding how to write a partnership agreement, work out how to plan for such contingencies.
Types of Partnerships
Depending on the state and the flexibility of the partners, you can draw up partnership agreements of different types.
The most common types of partnerships are:
A general partnership is one of the most common and basic partnerships you can have.
A general partnership agreement doesn’t require you to register it with the state.
They are very flexible as they are easy to form and dissolve. In most cases, they dissolve when a partner dies or goes bankrupt.
Profits are split evenly among members. Each of the partners has varying independent authority to bind the business to contracts and loans.
This is one major flaw as each partner is individually liable.
Limited partnerships must be registered with the state.
Each of the partnerships must have at least one partner who manages the business.
As well as other limited partners who are not involved in the running of the business.
Limited partners are not liable for the businesses’ debts and are just in it for the monetary returns.
This legal entity is popular when one needs to invest but is not willing to lose more than they invested in the business.
Limited Liability Partnership
All the partners are responsible for managing the business but are not responsible for errors committed by their fellow partners.
These types of LLC partnerships are common for certain professions especially in medicine, law, and accountancy. Additionally, they are not available in all states.
Limited Liability Limited Partnership
This partnership works as a limited partnership with one partner running the show.
The major advantage is that all the partners are protected from liability. They are common in Alabama, Arizona, Arkansas, Colorado, Delaware, Florida, Georgia, Hawaii, Idaho, Illinois, Iowa, Kentucky, Maryland, Minnesota, Missouri, Montana, Nevada, North Carolina, North Dakota, Oklahoma, Pennsylvania, South Dakota, Texas, Virginia, Washington, and Wyoming.
Unfortunately, you cannot use them in all states. When learning how to write a partnership agreement, factor in the regulations of the state where you work.
Many entrepreneurs enter into partnerships to raise finance for their ventures. But, you could consider other types of investors for startups also. Not sure what are your options? Check out this video I have created explaining the alternative sources.
Parts of a Partnership Agreement
Different agreements have different sections depending on their own complexity.
Partners should read through and find relevant sections to include in their partnership agreement. Here are some common sections:
Name of the Partnership
The name identifies the business to the rest of the world and confirms the business that the partnership agreement was drafted for.
Names sometimes incorporate the last names of the partners. Such as you see with law and accounting firms.
Also, ensure that the name isn’t trademarked by someone else to avoid legal issues in the future.
Partnerships are essentially about each one bringing something to the table.
In this section, you should highlight each partner’s contributions to the partnership.
The contributions highlighted here should be discussed in length and agreed upon before inclusion.
Contributions can be in the form of cash, property, or services to enable business operation.
This stage clearly highlights the ownership percentage of each partner to reduce frictions and ambiguities in the future.
Profit, Draws, and Loss Allocations
It is common for the profits and losses to be shared proportionally to the ownership percentage of the business. But it is perfectly acceptable to agree to another formula.
A common way is to give some partners a base salary, and then the partners will split any remaining profits.
You also have to agree in this section when the profits will be drawn and the percentage that can be plowed back into the business.
You should choose profit and loss allocation that best responds to different partners’ needs and financial situations.
It may seem trivial to include this section, but in the absence of a contract, any partner can bind the partnership to a contract or debt. Without consulting the rest of the partners.
It is therefore imperative to determine the kinds of decisions that need other partners’ consent and what decisions can be handled by one partner.
Partnerships are held together by consent.
Determine a process of decision-making on different issues for those that require unanimous votes and those that require a majority vote.
A partnership contract can help divide different management roles among the partners for effective management.
One partner can handle accounting, another customer care, another the employees, and so on.
It is in this section that you can determine the salaries, work hours, sick leave, and vacation policy for all partners. As well as performance-based splits.
The Process Of Admitting New Partners
What happens if you grow and need to bring new partners on board? This section ensures the process is much smoother when the need arises.
Adding this information is one of the nuances of learning how to write a partnership agreement.
Withdrawal Or Death Of A Partner
If you welcome new members, there are chances parties will leave. Try to create a good buyout scheme to make the process fairer and smoother.
Provide a mechanism for kicking out any free riders in the partnership. Decided what happens when a partner dies or is incapacitated.
A dispute is something that you will keep avoiding but will one day catch up with the business.
The method of resolution will determine whether you make or break the partnership.
Try to include alternate dispute resolution programs to reduce the chances of having to meet in court to solve issues.
Include The Duration Of The Partnership
Most partnerships will last indefinitely until the death of a partner, withdrawal, or bankruptcy of the partner.
You can, however, create a custom duration if the business is time-bound.
There is equally no harm in saying it will last indefinitely and provide solutions in case of death, bankruptcy, or partner withdrawal.
Terms And Conditions To Terminate The Partnership
Depending on your goals and visions, you may foresee a time or condition that may lead to the dissolution of the partnership.
Define the circumstances in detail, whether it is mutual consent, government regulation, company procedure, etc.
Different partnerships will have different agreements in place.
It is in the best interest of all partners to create an agreement that is sensitive and unique to their needs.
Take time to discuss research, plan, and learn how to write a partnership agreement.
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This post is for informational purposes only. You should consult with your lawyer for legal advise.