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Having a partnership agreement in place will provide structure to your business relationship with your partners and will protect you in the event that disagreements arise down the road. While states don’t require partnership agreements, clearly outlining your relationship will benefit you in the long run by taking the guesswork out of the operations of the business. By agreeing upon the terms and executing an agreement, you and your partner are also able to make decisions about the governance of the company outside of court.
In the absence of a partnership agreement, the default partnership laws of your state will control and you will each have less say in how your business is operated. Without an agreement in place, the default rules of general partnership mean that each partner will be equally liable for the profits and losses. An agreement can also provide a plan for how certain business decisions, internal problems and disagreements will be managed. If there are no defined methods of operation, disputes can quickly derail the company. The best time to enter into a partnership agreement is at the time when the company is formed.
What is the Difference Between an Operating Agreement and a Partnership Agreement?
Partnership agreements are used for partnerships whereas operating agreements are used for LLCs. Both an LLC operating agreement and a partnership agreement are documents that outline the internal governance of a business. Like an LLC operating agreement, a partnership agreement can be tailored to meet the needs and circumstances of your individual company. The terms in the agreement outline how you and your partner intend to operate the partnership, including how the profits and losses are shared, rights and responsibilities, and the duties and obligations of each partner.
An operating agreement essentially serves the same purpose for an LLC by detailing the terms of how the members and managers will operate the company. An operating agreement usually includes details about who owns the company, the number of employees, how the company will be operated, and how internal disputes are to be handled.
How Long Does a Partnership Agreement Last?
The partnership agreement lasts as long as the partnership itself. While the agreement should stipulate the duration of the partnership, they usually last indefinitely until a partner dies or withdraws.
What Should a Partnership Agreement Include?
There are several important provisions that should be included in a partnership agreement. Some of the most common and recommended are described below.
Ownership & Authority
Typically a partnership agreement will outline the ownership percentages and rights of each partner. Partners can agree on how much capital they will each contribute to the business as well as their individual contributions in the form of equipment, services, and property. These contributions are usually the basis for determining the percentage of each partner’s ownership.
It’s also a good idea to describe the roles of each partner and their authority to bind the company. An agreement can include provisions that expressly limit or divide this authority. Without this, either partner has equal authority to enter into a contract on behalf of the company and potentially put it at risk.
Division of Profit and Loss
Partners can agree upon their share of the profits and losses of each, usually calculated based on their ownership rights. The agreement can also state how much of the company’s profits can be withdrawn from the business at certain points in time or earnings milestones.
Duration of the Partnership
Partnerships can last for a certain amount of time or an agreement can stipulate that the duration is perpetual. Even if there is not a designated event or date when the partnership will dissolve, the agreement should specify a duration of some sort.
Procedures for Business Decision-making & Dispute Resolution
Many conflicts can arise in business, especially when ownership is divided among partners. For this reason, it is important to have provisions setting forth your company’s procedures for decision-making and resolving disputes. These procedures can include voting requirements for big decisions or a mediation clause.
Withdrawal, Dissolution, or Adding a Partner
It can also be stipulated that the partnership will dissolve upon the withdrawl or death of a partner. The provisions regarding withdrawal can include a buy and sell requirement. Additionally, there should be a plan for the sale of business property upon dissolution.
The agreement should describe the procedure for adding a new partner, including the necessary voting procedure for authorizing this addition as well any capital contributions required for the new partner to buy-in.
Do You Need a Lawyer For a Partnership Agreement?
The provisions in a partnership agreement can be confusing and since the language is binding on all parties, you might consider enlisting the help of a qualified attorney to draft and/or explain the terms with you. An attorney can evaluate the specifics of your business plan and help you determine what’s necessary to protect you and your company. Even if you opt to handle the formation paperwork yourself, investing in the legal fees to have a solid agreement drafted can be well worth it.
If you decide to go it on your own, you may want to look at your states Uniform Partnership Act (example search – “Colorado Uniform Partnership Act”) to review partnership legalities in your state.