Starting your own business is exciting and fun. You envision your dreams coming true and the world of great opportunities opens up. But it is a major decision, especially if you decide to go into business with a partner. Even though there is nothing fun about it, you should take the time to figure out how to write a partnership agreement.
If the rights and responsibilities of partners are not put down in a written form, any minor problem or misunderstanding could explode into a major conflict and potentially pose a threat to your business partnership. On top of that, if you don’t have a written agreement, your state law will become the default. All states, except Louisiana, have their own set of rules governing partnerships called the Uniform Partnership Act or the “Revised Uniform Partnership Act”—or, sometimes, the “UPA” or the “Revised UPA.”.While it might be tempting to rely on these laws, they may not cover your place of business situation. We strongly encourage you to buckle down and write an agreement which will take into consideration everything you and your partners agreed on.
What is a Partnership Agreement?
A partnership agreement is a legal document (pdf or physical) between two or more business partners who start and manage a business for profit. This contract defines the objectives of the business as well as the procedures for making the important decisions binding the partnership and helps dispute resolution . It also includes provisions that pertain to the financial aspects of the company and the partners’ authority in managing day-to-day operations.
The partners share all assets, profits, and liabilities. To avoid any future issues, it should be structured to clearly point out each partner’s responsibilities and rights, and cover all aspects of running the company, including what happens in the event of business dissolution or a partner’s death. While these more negative aspects are not necessarily things you want to think about happening just as you’re starting your business, it’s always best to be prepared. In the unfortunate event that a partner passes or you decide to close the business, having a process already agreed upon will take some pressure out of an already stressful period.
When you start out, do your own research and find a few samples of partnership agreements, just to familiarize yourself with the format. A good starting point is SCORE, where you can read articles, peruse partnership agreement templates, and even attend workshops for business owners. While you don’t necessarily need to hire a business attorney, it can likely save you a lot of money and headaches down the road if you consult one to review your document once you have it finalized.
What Should Be Included in Your General Partnership Agreement?
The first thing that has to be decided is the legal name of the partnership which will be entered in the agreement. You and your individual partners may agree on using your own last names or you may pick a fictitious name for your company. If you choose to register the business under a fictitious business name, make sure it’s not already been registered, and then file a fictitious business name statement with your county clerk
There are many areas of a business partnership that should be covered by a legal document. All partners should discuss in detail each of these clauses and agree to every single detail before you all sign written consent on the dotted line. While there are many variations in scope of business, number of partners, and business objectives, here is a list of some of the most important items that should be included in your partnership agreement, according to Investopedia:
Partners’ Capital Contributions: In this section of your partnership agreement you have to be specific about how much investment each partner will contribute to the business. Determine the individual share of startup costs and continuing expenses, as it will be much easier to figure out the course of action if the initial money unexpectedly runs out after a few months.
In case that partners are not contributing equal amounts of cash, it should be specified if one will be providing services or expertise in lieu of the capital and how to translate it into capital investment. If a partner contributes property to the partnership, the amount of the contribution is equal to the cash value of the property.These terms are extremely important, as they define the ownership percentage of the ownership each partner will have in the company.
Division of Profits and Losses: You and your partners need to agree on how to share profits and losses. If there is no partnership agreement, each partner shares equally as you are business co-owners. In your contract you have to determine if profits and losses will be shared proportionally according to the respective percentage of the ownership in the business, or will they be allocated equally between the partners without taking into consideration the individual investments.
It should also be specified if the profits will be disbursed at the end of the year or will each partner be allowed to draw an allocated sum regularly throughout the year. You and your partners may have different financial needs and different ideas about how the money should be divided up and distributed, so this is an area to which you should pay particular attention.(If your partnership is more complex and involves many partners, the issue of salary distribution should be addressed in a separate section.)
Partners’ Authority/Binding Power: You might be getting into business with your best friend or a close member of the family, but including this clause in your partnership agreement will bring you peace of mind and prevent unpleasant situations in the future. Without a written contract, each partner has equal right to bind on the business in its entirety, without seeking consent from the others. To avoid negative implications of these one-sided actions, the partnership contract should stipulate which partner holds the authority to make binding business decisions.
Decision-Making: You’ll be able to prevent a lot of trouble if you figure out how to lay out terms defining the decision-making process between partners of a business company beforehand. Most common disputes in a partnership occur when there is no clear definition on how the decisions are to be handled. Make sure to include a method of checks-and-balances as well as specific circumstances when the partners would be entitled to make decisions on their own, rather than seeking the consent of the other partners.
For instance, some minor issues would be best handled single-handedly, but if it is a major one, a unanimous vote might be necessary. The best approach would be to put in writing how to differentiate between these “minor” and “major” issues to fend off future disagreements. In addition, make sure to address dispute resolutions through a mediation clause to prevent going to court to settle conflicts between the partners.
Management: You don’t need to go into great detail to define every single step of your business operation in your partnership agreement, but it’s prudent to set some management guidelines in advance to avoid misunderstanding and confusion. Discuss the management needs of your company with your partners, divide tasks appropriately, and ensure you’ve got everything covered.
Decide from the beginning who will be best to deal with customers, who will take care of the accounting, who will supervise the employees, and who will be most successful in negotiating with vendors. Once you divvy up the roles, everybody will have a clearer picture of their day-to-day obligations and responsibilities.
Length of Partnership: A partnership agreement should include the information on length of the partnership, even if the time frame is not defined. Many companies continue functioning without time limits, but some businesses are set up to operate until a specific milestone is reached or to dissolve after a designated number of years.
Adding New Partners: As your business expands, you might want to bring in new partners. The partnership agreement should state the conditions and methods for admitting new business partners. You should include the specific instructions to ensure this process goes as smoothly as possible. For example, a new partner can join a business by making an investment or acquiring a previous partner’s interest in the company. The contract could also stipulate that all current partners have to give their consent to admit a new partner. Make your decisions ahead of time based on your business objectives and your partnership’s needs.
Withdrawal or Death: Nobody wants to think about a partner leaving or dying when launching a new business. But bad things happen and you should be prepared, even if it seems unlikely. Your partnership agreement should include a section with instructions on how to handle a departure of a partner with a reasonable buy-out agreement detailing the valuation process. In case of a partner’s death or disability, make sure to discuss wills, trusts, and life insurance policies, as each of you would have to decide how to handle this issue, who to trust to make decisions on your behalf, who should get your shares, and who your beneficiaries should be.
Starting a new business is an adventure filled with excitement but also with uncertainty. As co-owners, you and your partners have to decide on the objectives and business structure. To avoid potential disagreements and conflicts among partners, it is necessary to create a partnership agreement which will spell out the relationship between each partner, as well as the way the business is managed. While you are not required to hire an attorney to put everything you agreed on in writing, it will give yourself the gift of peaceful of mind if you consult a legal representative to take a look at your document to ensure all your goals and issues are covered.