In many ways, a business partnership is like a personal partnership. The people involved in both kinds of partnerships need to have clearly communicated understandings. In business, especially, those understandings should be in writing.
If something happens to a partner, there's a dispute between partners, or there is a change in the partnership, everyone needs to know "what happens if." A partnership agreement is the best way to assure that the business—and personal—part of the relationship can survive.
What is a Partnership Agreement?
A partnership agreement is a contract between partners in a partnership which sets out the terms and conditions of the relationship between the partners, including:
- Percentages of ownership and distribution of profits and losses
- Description of management powers and duties of each partner
- Term (length) of the partnership
- How the partnership can be terminated
- How a partner can buy his/her share of the partnership.
A partnership agreement should be prepared when you start a partnership. An attorney should help you with the partnership agreement, to make sure you include all-important "what if" questions and avoid problems when the partnership ends.
Read more about all the terms a partnership agreement should contain in "Partnership Agreement Terms."
The Importance of the Agreement
Basically, a partnership agreement is set in place to deal with every possible situation where there might be confusion, disagreement, or change.
Attorney R. Shawn McBride explains:
Partnership agreements are critical to good business operations when there is more than one owner. They act to set expectations and deal with what happens when things happen in the future. For instance, a good partnership agreement will say what happens in the event of a death, disability, divorce or disagreement.
Without a good partnership agreement, you could end up in the court waiting for a judge to decide what happens to your business rather than simply following what is written in the partnership agreement. And the court process is always expensive, time-consuming and bad for business.
Here's why every partnership should have an agreement, right from the beginning:
- To set up the roles and responsibilities of each partner and to describe how decisions are made. Who is the managing partner? What are the responsibilities of individually named partners? How do roles and responsibilities change?
- To avoid tax issues, by having the tax status of the partnership spelled out, and to show that the partnership is distributing profits based on acceptable tax and accounting practices.
- To avoid legal and liability issues, spelling out the liability of individual partners (general partners vs. limited partners) and the liability of all partners if there is a liability issue with one partner.
- To deal with changes in the partnership due to life challenges of existing partners - partners who leave, become ill or incompetent, get divorced, or die. These are usually dealt with in buy-out agreements with each partner.
- To describe the circumstances under which new partners can enter the partnership.
- To deal with partner issues, like a conflict of interest and non-compete agreements.
- To override state laws. Some states have required language in partnership agreements. But this language may not be the best for your particular partnership. If you don't have a formal written agreement, you may find yourself having to abide by the default state laws.
- To make disputes easier. It's a good idea to include language in your partnership agreement that describes how disputes will be handled. Will arbitration be a possibility? What will be the responsibility of parties to the dispute? Who pays for what?
Why You Need an Attorney to Help Prepare a Business Partnership Agreement
The only disadvantage to having a partnership agreement is that you might have language that is unclear or incomplete. A DIY partnership agreement risks not getting the wording right, and a poorly worded contract is worse than none at all.
Getting an attorney to help you with the process of preparing your partnership agreement seems like it's an expensive waste of time. It's not. Remember, if it isn't in writing, it doesn't exist, so putting every possible situation or contingency into a partnership agreement can prevent expensive and time-wasting lawsuits and hard feelings between the partners.
Disclaimer: The information in this article, and on this site, is intended to be for general information purposes. I am not an attorney or CPA, and you should talk to your legal and financial advisors before entering into any contract.