When two or more people start a business, they need to agree on how the business will be conducted. This will help the partners to prevent any future disagreements, and if any emerge, there should be a detailed legal mechanism on how to resolve them. There are so many things that partners should agree on including how much partners will contribute to the formation of the business, how they will be salaried, and what duties each partner is responsible for. These aspects should clearly be delineated in a partnership agreement.
So what is a partnership agreement? This article highlights what this agreement is, its importance, and things to consider when drafting it.
What Is A Partnership Agreement?
A partnership is a business with two or more people, with each owning part of the business. The partnership agreement sets out all the terms and conditions that the parties agree to when forming a partnership. In fact, the partnership agreement is the most important document for a partnership. If a partnership begins without an agreement, it can be jeopardized if something happens to one or more of the partners.
In the partnership agreement document, every possible contingency is included, such as profit sharing ratios and the duties and responsibilities of each partner among other aspects. In the partnership, each partner should buy in or invest in the partnership and they typically share the profits and losses based on the percentage share of ownership.
Why Involve An Attorney
The partnership agreement is a binding contract. Since it is a legal document, this implies that it is best to have an attorney guide you and provide the much-needed advice when including terms and clauses in the agreement. This way, it will provide adequate guidelines on all business aspects that need to be covered in the contract.
Is There A Need For A Partnership Agreement?
Running a business on a handshake is not the smartest idea since there may be disagreements, which may prove difficult to resolve if there are no clear set guidelines. Having a partnership agreement gives you and your partners the protection you might need just in case something happens that may endanger the business relationship. It answers the “what if” questions so you don’t have to deal with them when a crisis strikes. For instance, if a partner decides to leave the agreement, it has clearly set guidelines on what should happen.
A partnership agreement is vital as it includes and guides partners in all the following aspects:
- 1Name of the partnership. There are various types of partnerships, such as LLCs and joint ventures, and the name should be specified in the partnership agreement.
- 2The term of the partnership. Partnerships can be perpetual or span a specific term length.
- 3Name the partnership is doing business as (if different). For instance, if the business is under different names or offers different types of services.
- 4Purpose of the partnership. This entails specifying the activities that the business engages in. This includes the products and services sold and how new services or products will be added.
- 5The requirements of admitting new partners, including their contributions.
- 6Types of partners in the partnership. Some of the partners may have more day-to-day duties, such as the general partners, while others may just contribute and have limited participation.
- 7Types of partners in the partnership. Some of the partners may have more day-to-day duties, such as the general partners, while others may just contribute and have limited participation.
- 8Each partner’s contribution. This should be specified so that when profits are made, the partners can share according to the amount they contributed. Contributions could be in cash, installments, property, or service.
- 9The agreement should specify what happens in the event that a partner fails to make the initial contribution.
- 10It should also clarify whether there will be additional future contributions when the contributions will be accepted, and how they will affect the shares for each partner.
- 11How profits and losses made through the proceeds of the business will be shared or distributed among the partners, in terms of percentages (percentages, unequal, equal).
- 12How decisions for the business will be made.
- 13Duties and responsibilities. Each partner should have an assigned duty and management power, including the skills contributed and the hours for work for each partner.
- 14Draws to partners. When and how partners should take a draw from the partnership share.
- 15Financial matters, such as how periodic financial statements and books will be kept and when taxes will be filed.
- 16The power to be vested in partners to borrow money on behalf of the partnership. How the power is distributed and whether a vote is required to borrow a certain amount.
- 17Maintenance of records. This entails how and where the records will be kept.
- 18Meetings. The agreement should clarify when meetings will be held and how many partners will constitute a quorum for meetings.
- 19The agreement should specify the power of authorizing expenses and the signatures needed.
- 20The partner time off, including vacations, leaves of absence, and sick leaves should be clearly specified.
- 21Ownership of assets. The agreement should specify if the partnership owns all assets or whether some are held by the partners.
- 22Outside activities (those that are restricted and permitted), and the conflict of interest policy.
- 23Sale or the transfer of a partner’s interest to another partnership, at retirement or another event. It should specify aspects like buy-sell agreements for the partners and the methods involved.
- 24Non-competition clause. This restricts partners who leave the partnership from competing with the business, within a defined time period and area.
- 25Continuity of partnership business when a partner dies, leaves, or is terminated as in the case of a buy-sell agreement.
- 26Expulsion of a partner from the partnership.
- 27Amendments to the partnership agreement, how and when.
- 28Severability if a part of the agreement is found to be invalid and doesn’t affect the contract.
- 29Adherence to state law. This is mainly for the purpose of litigation and establishing the state in which the litigation will be held.
- 30Mediation and arbitration of the dispute, including mandatory arbitration, if the partners agree to it.
Provide Information On Things You Should Know About A Partnership Agreement
We compiled 8 vital things you should know about the agreement, which are:
This highlights what to do if something happens regarding the ownership. If you sell the business, the agreement should specify which partner will get what and the partnership’s position of including new partners. Here, the agreement states whether there is the option of buying out another partner. Therefore, the agreement should explicitly describe how ownership interests should be handled in different scenarios, including in the event that a partner retires, dies, or in case of bankruptcy. Include a non-compete clause to prevent a partner from competing with the business once he or she leaves.
2. Critical Developments
The agreement should cover for unexpected occurrences, such as when a partner gets sick or is dying. It also covers what will happen in case of a buyout. It should set retirement provisions and circumstances in which you can change the partnership.
3. Dispute Resolution
While no one wants to think about this, things could get ugly between partners, which is why you should consider this in the agreement. There should be a mediation and resolution process if disputes arise as it might save partners from lawsuits.
4. Dissolution Or Exit Strategy
The agreement should show the events that could trigger dissolution and how the affairs that would be affected would be wound up. This includes all legal means of ending the partnership. This is a security if you or your partners can’t agree on the future of the business. You also need to know the state requirements of dissolving the partnership.
5. Decision Making
This is a safeguard since you won’t be agreeing on everything. Therefore, define how daily management and long-term decisions will be made. Define who gets the last say and the type of decisions that require unanimous votes by the partners, and what decisions can be made by a single partner.
The agreement should clarify what each partner must stake in the formation of the partnership, and the ongoing finances of the business. It should specify how much each partner should contribute to the commencement of the business. Besides, it should state the responsibilities of each partner in the future needs of the business, including equipment, customers, effort, and time.
7. Partner Roles In Signing And Authorizations
There should be a clear understanding of what the offices or managers of the business are authorized to do on behalf of the business.
The partnership agreement should detail how partners will share profits, how much each partner will be paid. The agreement should also include the salary for each partner.
Every partnership should have an agreement to make sure that every potential situation is covered for. The partnership agreement is a binding contract, which implies that you need an attorney to guide you to draft it, and also help resolve any future disputes or issues. In most instances, it should stipulate that what matters partners should vote for, their contributions, distributions, what should be implemented, ownership, critical developments, dispute resolution, dissolution or exit strategy, and partner roles in signing and authorizations among other aspects.
However, periodic reviews and additions are paramount and keep up to date with legal requirements. We hope this article has adequately addressed what a partnership agreement is, why it is important, and things to consider when drafting one.