Establishing a partnership ― whether it’s a general partnership, limited partnership, etc. ― is an exciting time for business professionals. By working together toward a common goal, entrepreneurs can combine resources, clients, expertise, and more.
Joining forces isn’t an automatic process, though. Even if you’re forming a general partnership, which requires no actual formation process, partners need to establish policies for how their new business will work. That’s where the partnership agreement comes in.
In this article, we’ll discuss all the important details of the partnership agreement. Who needs one? What information should it include? Is it legally required? Read on to discover the answers to these questions and many more.
What Is a Partnership Agreement?
A partnership agreement is a contract that’s written by the partners, for the partners. The agreement outlines the practices and policies for doing business together, and should be created when you first start your partnership.
A partnership agreement is very similar to an LLC’s operating agreement or a corporation’s bylaws. The agreement helps the business succeed by establishing a battle plan for daily operations, but it is not legally required by your state government.
Why Does the Partnership Agreement Matter?
Working together is exciting, but it can also be stressful. One partner can do something that rubs the other partner the wrong way, finances can fail, or someone might fail to pull their weight.
All these situations can cause tension between partners, and even lawsuits if things get carried away. The partnership agreement helps resolve these disputes before they happen by prescribing what needs to happen in those circumstances.
Technically, a partnership does not have to write a partnership agreement, as verbal agreements are legally sufficient. Still, a written agreement is much easier to enforce, as it serves as proof of the understanding between the partners that the business will operate a certain way.
If things go south and you and your partner(s) end up in a lawsuit, the agreement proves the rights and privileges that you agreed on together.
What Should a Partnership Agreement Include?
No two partnership agreements are exactly alike, but all the good ones contain most of the same basic components. Let’s briefly go over what each of those crucial components looks like.
- Roles and responsibilities of each partner: The partnership agreement should define exactly what each partner does for the business. Essentially, this section will set the job description for every partner. There could also be a portion establishing which person is the managing partner, as well as outlining each partner’s rights to sign contracts and make business decisions.
- Liability of each partner: If a problem arises with one partner’s liability, you’ll be glad you wrote this section about how each partner’s liability affects the liability of the other partners. Furthermore, if your business is a limited partnership, you’ll want to clearly define who the general partners are and who the limited partners are in your business.
- Distribution of profits: How you split the profits in your partnership is entirely up to you, but it’s something you should agree on in advance. An even split works for some partnerships, but if in your partnership, one person does 30% of the work and the other does 70%, you’d want to get your fair share of the profits.
- Length of the partnership: Not all businesses last forever, and sometimes, partners plan to be in business for a set period of time before going their separate ways. Your agreement should put this period in writing, or designate the business as perpetual.
- Conflict of interest policy: Sometimes, self-serving partners use the business to further a personal agenda that hurts the business as a whole. To help avoid these conflicts of interest, a partnership agreement should clearly define the consequences for a member that hurts the business through conflicting pursuits.
- Changes in partners: Sometimes a partner wants to buy out another partner’s share in the business, or a new partner wants to join in. Maybe one of the partners retires or dies. Your partnership agreement should set up clear procedures for adding or removing partners.
- Unique features of your business: No two partnerships are exactly alike, and so these components might not cover every important aspect of your business. If there’s a unique feature of your business that you think needs to be addressed, you can include it in your agreement.
- Policies for amending the agreement: Your partnership agreement should match your business practices perfectly at first, but that doesn’t mean it always will. Businesses change over time, and what worked in the past might not work later on. That’s why you should include procedures for amending your agreement.
What Happens if There Is No Partnership Agreement?
Technically speaking, a partnership does not need to have a partnership agreement in order to operate in a compliant fashion. However, if you don’t write one, your partnership is governed by your state’s default laws for a partnership, which in most states are outlined in the Revised Uniform Partnership Act.
That said, letting the defaults cover your business isn’t always the wisest decision. All partnerships are allowed to modify the rules laid out in the Revised Uniform Partnership Act to suit your specific business.
Writing up an agreement to describe these rules lets you operate your partnership the way you and your partners want to, rather than operating under generic rules that were written over 20 years ago.
To write an agreement, you’ll want each partner to participate. You can write it together from scratch or a template, but if you have the means, it’s a good idea to enlist an attorney for this step. That’s the easiest way to avoid overlooking important language that you should include, and a lawyer will also help you avoid any loopholes.
A partnership agreement isn’t legally required for any form of partnership, even those that involve filing formation documents with your state government (like a limited partnership or limited liability partnership). Still, failing to create a partnership agreement leaves the door open for disputes between partners down the line.
Especially considering that it doesn’t take a tremendous amount of effort to write one, your partnership should absolutely have such an agreement, as it can prevent a variety of issues in the future.