Table of Contents
1. The Basics: What is a Partnership Agreement?
A Partnership Agreement is an internal written document detailing the terms of a partnership. A partnership is a business arrangement where two or more individuals share ownership in a company and agree to share in the profits and losses of their company.
There are three general types of partnerships:
1. General Partnership:
In a general partnership, all of the partners are on equal footing. They have equal rights and responsibilities, and each individual partner can act on behalf of the agreement as a whole.
They share in the profits, but they also share in the losses. Each individual partner is also personally on the hook for any actions of the team – this is called joint and several liability.
2. Limited Partnership:
Here, the partners are on unequal footing. On one side is the general partner, who manages the business and has the same rights and responsibilities as the partners in a general one, including joint and several liability.
On the other side is the limited partner – or silent partner – who contributes money, but is not involved in the day-to-day of the business. The limited partner is not personally on the hook for the actions of the partnership or the general partner.
3. Limited Liability Partnership:
This is a hybrid between a partnership and a corporation. None of the partners are personally responsible for the liabilities of the others and the other partners beyond their assets in the partnership. The partners can choose how much they want to contribute and how involved they want to be in the business.
Limited liability partnerships are a more formal structure and require registration with the state and usually a written agreement as well. Their use is also limited in certain states to professional partnerships, such as lawyers and accountants.
The pros and cons of different types of agreements
Here is a simple chart detailing some of the pros and cons of a General Partnership, a Limited Partnership and a Limited Liability Partnership:
|General Partnership||- Fewer start-up costs|
- Less paperwork
- Simplified taxes
|- Joint and several liability
- Shared management
- Unattractive to investors
|Limited Partnership||- Limited liability for limited partner|
- Attractive to investors
- Tax benefits
|- Joint and several liability for general partner
- More paperwork
- Divided authority
|Limited Liability Partnership||- Limited liability for all partners|
- Flexibility for partners
- No double taxation
|- Formal filing requirements and more paperwork
- Use limited by certain states
- Tax limits in some states
A simple Partnership Agreement will identify the following basic elements:
- Partners: the names of each person who owns the company
- Name: the catchy new name
- Purpose: the business of the partners
- Place of Business: where the partners go to work every day
- Distributions: how the profits and losses are divided
- Partner Contributions: how much and what each partners is contributing e.g. cash, a brilliant new idea, industry knowledge, supplies, furniture or a workplace
As a reference, this agreement is known by other names:
- General Partnership Agreement
- Business Partnership Agreement
- Partnership Contract
- Articles of Partnership
- 50/50 Partnership Agreement
An alternative business structure to a partnership is a joint venture. If you’re interested in creating a Joint Venture Agreement, first learn more about joint ventures.
2. When This Agreement is Needed
Any arrangement between individuals, friends, or families to form a business for profit creates a partnership. As there is no formal registration process, a written Partnership Agreement shows a clear intention to form a partnership. It also sets out in writing the nuts and bolts of the partnership.
Investors, lenders, and professionals will often ask for an agreement before allowing the partners to receive investment money, secure financing, or obtain proper legal and tax help.
3. The Consequences of Not Using This Agreement
Without this Agreement, your state’s default partnership rules will apply. For example, if you do not detail what happens if a member leaves or passes away, the state may automatically dissolve your partnership based on its laws. If you want something different than your state’s de facto laws, an agreement allows you to retain control and flexibility on how the partnership should operate.
Most states have adopted the Uniform Partnership Act (1914) or Revised Uniform Partnership Act (1997).
You may also be subject to unexpected tax liability without an agreement. A partnership itself is not responsible for any taxes. Instead, a it is taxed as a “pass-through” entity, where the profits and losses pass through the business to the individual partners. The partners pay tax on their share of the profits (or deduct their share of the losses) on their individual tax returns.
Without an agreement that clearly spells out each partner’s share of the profits and losses, a partner who contributed a sofa for the office could end up with the same amount of profit as a partner who contributed the bulk of the money to the partnership. The sofa-contributing partner could end up with an unexpected windfall, and a large tax bill to go with it.
This agreement also allows you to anticipate and settle potential business conflicts, prepare for certain business contingencies and clearly define the responsibilities and expectations of the partners.
Here is a chart of some of the consequences individual members may face if there is no written Partnership Agreement.
|-Loss of Time|
-All members must meet and vote on both big and small company decisions
|-Loss of Time
-Subject to state default laws that may change or be amended without notice
-Personal life may be interrupted if a partner is unable to leave the partnership
-Business activities are interrupted if a partner leaves and partnership cannot purchase his or her ownership interest
|-Default 50/50 ownership regardless of contributions||-Disproportionate allocations amongst partners|
|-Increased tax liability||-Disgruntled partners|
|-Accidental partnership||-Accidental partnership
|-Loss of friendship or family trust||-Loss of business relationship|
Read this article from Entrepreneur discussing the importance of a having a written Partnership Agreement.
4. The Most Common Partnership Situations
Any group of individuals who form a business partnership, whether it be family, friends, or random acquaintances off the internet, should invest in a Partnership Agreement. This agreement allows individuals more control over how their partnerships are run on a day-to-day level and managed on a long-term strategic level.
For instance, state default rules often assume that each partner has an equal share of the partnership, even though they may have contributed different amounts of money, property, or time. If you want something different than the default, this agreement allows you to divide profits and losses equally among partners, according to each partner’s contributions or a according to your own percentages.
A limited liability company is a more formal business structure that combines the limited liability of a corporation with the tax benefits of a partnership. If you’d like to find out more, read our article about limited liability companies.
5. What Should be Included in This Agreement?
A simple Partnership Agreement should generally have at least the following:
- Who are the partners
- What did each partner contribute
- Where are you doing business
- When does it begin and end
- Why was it formed
- How are profits and losses distributed
Here are some other useful details a Partnership Agreement might include:
- Capital Accounts: the members will keep a separate account for each partner’s capital contributions
- Income Accounts: the members will keep a separate account for each partner’s profits and losses from the partnership
- Salary and Drawing: will the partner’s receive a salary and can they withdraw from their income account at will
- Bank Accounts: the members will keep a separate account for the partnership’s funds
- Books and Records: how the members should maintain its books and records and who can inspect them
- Management: how the partners will be managed and the duties of the partners
- New Partners: when and how can new partners join the partnership
- Dissolution: when and how the partnership will be dissolved
- Withdrawal: when and how a partner can leave the partnership
- Retirement: what happens if a partner retires
- Removal: how to remove a partner
- Death: what happens if a partner dies
- Buyout: whether other partners have the right to buyout another partner’s interest if he or she leave the partnership
- Restrictions on Transfer: are there any restrictions on a partner’s ability to transfer his or her interests in the partnership
- Arbitration: how will disputes about the agreement be resolved
- Governing Law: which state’s laws apply if there is a problem with the agreement
You must also make sure to register your partnership’s trade name (or “doing business as” name) with the appropriate state authorities.
In order to have a successful partnership, it is important to go into business with people you trust and work well with. Read this article from Entrepreneur about building a partnership that lasts.