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 main types of partnerships: general, limited, and limited liability. Each type impacts your management structure, investment opportunities, liability implications, and taxation. Record the kind of partnership you and your partners choose in your partnership agreement.
A simple Partnership Agreement will identify the following essential 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 partner 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
Before signing an agreement with your partner(s), understand a partnership’s advantages and disadvantages. An alternative business structure to a partnership is a joint venture which requires a Joint Venture Agreement.
When to Use a Business Partnership Agreement
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 often ask for an agreement before allowing the partners to receive investment money, secure financing, or obtain proper legal and tax help.
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, 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 tax returns.
Without an agreement that 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 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 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
|-Loss of friendship or family trust
|-Loss of business relationship
The Most Common Partnership Agreements
Any group of individuals who form a business partnership, whether 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. Suppose you want something other than the default. This agreement allows you to divide profits and losses equally among partners, according to each partner’s contributions or your percentages.
A limited liability company is a more formal business structure that combines a corporation’s limited liability with a partnership’s tax benefits.
Start an LLC with an LLC Operating Agreement.
What to Include in a Partnership 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 valuable 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 partners 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 buy out another partner’s interest if they leave the partnership
- Restrictions on Transfer: are there any restrictions on a partner’s ability to transfer their 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 register your partnership’s trade name (or “doing business as” name) with the appropriate state authorities.