1. What is a Partnership Agreement?
A Partnership Agreement is an internal written document detailing the terms of a business partnership. A partnership is a business arrangement where two or more individuals share ownership in a company and agree to share in their company’s profits and losses.
There are three main types of partnerships: general, limited, and limited liability partnerships. Each type has a different impact on your management structure, investment opportunities, liability implications, and taxation. Make sure to record the type of partnership you and your partners choose in your partnership agreement.
A simple Partnership Agreement will identify the following basic elements:
- Partners: the names of each person who owns the company
- Name: the name of the business.
- Purpose: the type of business being run by the partnership
- Place of Business: where the partners go to work every day
- Distributions: how the profits and losses are divided amongst partners
- Partner Contributions: how much and what each partner is contributing e.g., cash, a brilliant new idea, industry knowledge, supplies, furniture, or a workplace
Before signing an agreement with your partner(s), make sure you both understand the advantages and disadvantages of a partnership.
Partnership Agreement Sample
The sample partnership agreement below details an agreement between the two partners. In this partnership agreement, the partners agree on the establishment and terms of the partnership.
2. 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 important details of how the partnership will run.
3. Why it’s Important to Create a Partnership Agreement
Without a partnership agreement, your state’s default partnership rules will apply. For example, if you do not detail what happens if a partner 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, a formal partnership agreement allows you to retain control and flexibility on how the partnership should operate.
You may also be subject to unexpected tax liability without a partnership 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 individual tax returns.
Without a partnership 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.
A partnership agreement also allows you to anticipate and settle potential business conflicts, prepare for certain business contingencies, and clearly define the partners’ responsibilities and expectations.
4. What to Include in a Partnership Agreement
A general Partnership Agreement should generally have details outlining 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
- What will happen if a partner leaves or passes away
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 leaves 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.