When deciding how to legally structure your business, there are various factors to consider. One form of organizing the business — a partnership — may best fit your needs. Even if you choose to enter into a partnership, there is no requirement that you draft a formal agreement. But memorializing your expectations, obligations, and requirements in writing can help prevent future disagreements.
What is a Partnership Agreement?
A partnership agreement is a legal contract between two or more partners that defines each party’s role in the business. It can function as a business plan that defines each partner’s investments, liabilities, responsibilities, and more.
Partnerships can be established without a signed agreement and are governed by state law. Most states have enacted the Uniform Partnership Act, which lays out minimum standards. A partnership agreement is legally binding and can address areas and practices not covered by state partnership laws.
There are two main types of partnership agreements: general and limited. A general partnership is owned by two or more individuals who have an equal stake in the company. All partners will share the profits and can face unlimited liability for any losses.
A limited partnership agreement governs a company where there are one or more general and limited partners. A limited partner’s risk is restricted to how much they personally invested. Limited partners may have a formal day-to-day role in the partnership’s operations, or they can be silent and have no involvement. The general partner or partners of a limited partnership still maintain full responsibility for the company’s profits and losses.
How a Partnership Agreement Protects Your Business?
There are numerous benefits to formalizing your business structure with a partnership agreement. In a worst-case scenario, a handshake or verbally agreed to partnership can fall apart in contentious litigation. When losses mount, your purported partner or partners may claim that they are not liable for their fair share.
Even if that disaster is avoided, memorializing all investments in writing helps in the calculation of who receives profits or suffers losses. It’s best practice to use a partnership agreement from start-up, but there is never a wrong time to formalize the role of each stakeholder in a legal document.
Writing down the expectations of each partner and the penalties for failing to carry out these responsibilities can prevent future conflicts. A well-drafted partnership agreement can also address an exit strategy for partners. Both in terms of how much it costs to buy-out one partner’s stake or how much a partner may owe for past losses, partnership agreements can avoid lawsuits.
We made it simple to tailor a partnership agreement to your exact specifications. You can download a complete agreement the same day you start it! Check out our contract maker tool to get your partnership agreement today.
Terms of a Partnership Agreement
All company documents and contracts should be representative of your business operation’s unique circumstances. You can always add additional terms to suit your needs, but all well-drafted partnership agreements should include:
Name of the Partnership and Principal Office
The agreement must identify the business' name as registered in state databases and should include any Doing Business As names as well. The mailing address of the partnership’s head office and contact information will also be included in this section.
Percentage of Ownership and Contribution
Include an exact accounting of each partner's investment in the company and what share of the business they own. This section can also determine if repeated or future investments will be required, how much, and when.
Distribution of Profit and Loss
All partnerships aim to be profitable. Once the company is in the black, the agreement should describe what will be paid, when it will be paid, and, crucially, the order in which profit is paid out. The agreement should also contemplate losses and which partner will cover what percentage of the loss.
Procedures for winding-down or ending the partnership must be addressed in the agreement. Some partnerships may be designed to end after a period of years or upon achieving a goal. This section can also add provisions for buying out a partner’s stake and what someone may owe when seeking to leave. It is also wise to discuss procedures for a partner's untimely death.
Partner Roles and Decision Making
Whether you are running your small business as a limited or general partnership, business decisions can be controversial. The terms of the agreement need to explicitly state which partner has authority for decision making and in what circumstances. The responsibilities of each partner, whether general or limited, also should be clearly described.
There are several avenues by which partner conflicts are resolved. Mediation, arbitration, and litigation are all options if partners cannot come to their own resolution. Choosing a default dispute resolution method makes all parties aware of their rights in advance.
Typically, each general partner will have the authority to make binding decisions on behalf of the entire partnership. This includes binding the company to a loan or other contract. If you want to limit these powers or only allow them in certain situations, include a binding provision within the partnership agreement.
Unexpected events, such as a partner becoming incapacitated due to an illness or accident, can occur at any time. Financial pressures may force a partner into a buy-out or retirement. An opportunity to add new partners that would benefit the company may arise. Addressing how the partnership agreement can be modified, and in what scenarios, will provide a path for handling difficult situations or seizing on a sudden windfall.
With our contract maker, you can create a well-drafted partnership agreement that can help avoid future conflict. In as little as a day, you could have a simple but effective partnership agreement in place for your business.
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