Deciding to go into business for yourself is a major decision, but joining forces with a partner is a completely different ball game. If you're considering starting a business with a partner, you may want to structure your business as a general partnership.
General partnerships are among the most common legal business entities, granting ownership to two or more people who share all of the assets, profits, and liabilities. In a general partnership, each person is responsible for the business and liable for the actions of their partner(s). To minimize the risk of serious conflicts with your business partners in your business journey, you'll want to write a partnership agreement before moving forward.
A business partnership agreement is a document that governs a general partnership between individuals or entities. It outlines the terms and conditions of the partnership, including each partner's rights, responsibilities, and profit-sharing arrangements. Read on to learn more about writing a general partnership agreement.
[Read more: What Is a General Partnership?]
What is a partnership agreement, and why do you need one?
Partnership agreements are mostly governed by the Uniform Partnership Act. This regulation applies to partnerships in 44 of the 50 states and districts. It has been revised multiple times since its original passage in 1917 and is sometimes known as the Revised Uniform Partnership Act (RUPA).
The RUPA becomes relevant in cases where a partnership agreement is vague. The RUPA serves as a default legal framework for partnerships, particularly in states where it has been adopted. Understanding RUPA can provide a good starting point for crafting a partnership agreement that suits your unique position.
Partnership agreements are a protective measure to ensure that disagreements can be resolved quickly and fairly. It also helps guide what actions should be taken if the partners wish to dissolve the working relationship or business.
Nolo noted that because you and your partners are equally responsible for the business and the outcomes of one another's decisions, creating a partnership agreement is an advantageous way to formally structure the relationship with your partners that best suits the business and the partners’ best interests.
What should be in a partnership agreement?
Your partnership agreement needs to cover a lot of ground. According to Investopedia, it should include the following:
- The name of your partnership. While it may seem like common sense, one of the first things you and your partner(s) must agree on is the name of your business.
- Contributions to the partnership and percentage of ownership. Create a list of specific contributions you and your partner(s) will make to the business. In addition to contributions, you must decide on the ownership percentage, which is typically dictated by each partner’s contributions to the business.
- Division of profits, losses, and draws. You and your partner must decide how to divide the business’s profits, losses, and draws. Partners can agree to share the profits and losses according to their ownership percentage, or they can be distributed equally among the partners regardless of one’s ownership stake.
- Partners' authority. Partnership authority, also known as binding power, should be defined within the partnership agreement. The ability to bind the business to a debt or a contractual agreement can expose the business to unnecessary risk, which is why the partnership agreement should explicitly state which partner(s) has binding authority.
- Withdrawal or death of a partner. When you’re launching a new business, no one wants to consider the possibility of a partner's withdrawal or untimely death, but it is something that needs to be clearly stated in the partnership agreement. The agreement should also outline the valuation process for the business and/or any requirements for maintaining a life insurance policy designating the other partner(s) as the beneficiaries.
How do you structure a 50/50 partnership?
- Discuss/agree on important details before drafting. Structuring a 50/50 partnership requires consent, input, and trust from all partners. To avoid conflict and maintain trust between you and your partner(s), discuss all business goals, the commitment level of each partner, and salaries prior to signing the agreement.
- Consult with an attorney. Before you draft or sign a partnership agreement, consult an experienced business attorney to protect everyone's investment in the partnership and business.
- Provide both partners with equal access to all fixed assets. In running your business, you and your business partner will have separate roles and responsibilities but complete and equal access to all fixed assets, including any property and equipment you've invested in. Including this detail in your business partnership agreement helps ensure total transparency and trust between you and your partner.
- Include a dispute resolution process. With responsibility for the business split between partners and the high cost of taking legal action, include an official dispute resolution process in your partnership agreement to help resolve arguments.
- Determine how partners will be paid. Your partnership agreement should outline reasonable salary expectations for yourself and your partner. Everyone, investors included, should agree to the terms before finalizing the partnership.
[Read more: How to Create a Business Partnership: Key Steps and Legal Considerations]
Business partners with equal ownership sometimes hit a wall when they can’t agree on critical decisions. This paralysis of company operations creates deadlock situations.The Jacobs Law
Can you change or modify a partnership agreement?
The short answer is yes, you can change or modify a partnership agreement. The RUPA states that a partnership agreement can be amended at any time with the unanimous consent of all partners.
“Partnerships may file the required forms to convert from a limited to a limited liability partnership, to convert to a general partnership or to reverse an earlier conversion. The effect of these actions that require a unanimous vote is to amend the partnership agreement," wrote Chron.
Advantages of a partnership
In more detail below are five advantages of a general partnership.
Easy to establish
Establishing a partnership is simpler and more straightforward than other business structures. Once you've drafted a partnership agreement, all partners must agree to the terms listed and sign the document. Unlike other business entities, you don't have to file federal paperwork — you simply file a few documents locally, like a trade name application and partnership authority.
Easy to dissolve
Partnerships can be easy to dissolve. If all partners agree to dissolve the partnership amicably, refer to the dissolution clause in your partnership agreement and follow its terms.
Additionally, you must consult your state's laws regarding partnership dissolutions, and you may need to file a statement of dissolution. If you and your partners can't dissolve the partnership amicably, it could complicate the process, especially if legal action is necessary.
Simplifies your taxes
With partnerships, you don't have to file additional business entity taxes. Your business taxes pass through to the owners, which means you'll need to include your share of the business profits and losses in your individual income tax filings. You're also responsible for paying any additional taxes individually.
Involves extra help and knowledge
Business owners perform multiple roles, but when you have a business partner to rely on, you can accomplish more together than if you were managing everything by yourself. A business partner also brings their expertise to the company, which could differ from your knowledge and experience. Ideally, your partner has skills and expertise that complement and enhance your own.
Carries less of a financial burden
Rather than the heavy financial responsibility that comes with starting a business alone resting on the shoulders of a sole owner, the addition of a business partner can help ease some of the financial strain. Having a partner who can help cover hefty startup costs can be a massive relief to business owners, with the added benefit of additional upfront investment, as well as a reduced risk of incurring significant debt since you’re dispersing those costs among the partners.
Disadvantages of a partnership
Partnerships also come with a few disadvantages. Below are four drawbacks of a business partnership.
Personal assets are not safeguarded, nor are they separate from the business
Unlike other business structures, a partnership does not create a separate legal entity shielding you from the company or from you and your partner(s). You are liable for the legal or financial difficulties your business may face. Your personal assets could be at risk since they are not covered by the partnership agreement.
Mutual liability
You are legally and financially responsible for your partner and the business when starting a partnership. If your partner creates legal trouble for the company, you become liable and open to legal prosecution as well.
These situations not only strain your relationship with your business partner, but they also affect your personal finances because, as mentioned above, there's no legal separation from the business unless you dissolve the partnership.
Provides less independence
Unless explicitly stated in your partnership agreement, your partner has an equal say in all business decisions. If you and your business partner disagree on fundamental decisions regarding the business, such as expansion opportunities, bringing on a management team, or selling the business, it could cause more serious disagreements between you and your partner, hinder growth, or jeopardize the company.
Obligated to split profits
Having a partner means there's someone to help cover the business's costs, but that also means you'll need to split the profits with them. If you have multiple partners, you could have a significantly smaller profit margin than if you started the business by yourself.
Business partnership agreement mistakes to avoid
As you write a partnership agreement, try to avoid these common pitfalls that can cause headaches later.
Not discussing an exit strategy
Partnerships evolve and dissolve for many different reasons. Perhaps one partner is ready to retire, start a new venture, or simply cash out. Or maybe you decide the company has run its course and the partnership needs to be dissolved. When this happens, you need a game plan.
"Here, you'll want to address everything from partner compensation once they leave the business to how assets and proceeds will be divided if the business is sold," wrote Stevens & Malone.
Ensure that your agreement answers questions like who is a partner permitted to sell their business interest to? How will each partner's interest be valued? What happens to a partner's interest if they become incapacitated?
Choosing the wrong partnership structure
Partnership agreements govern different types of partnerships, such as general partnerships and limited liability companies. Unless otherwise specified, a business partnership is considered a general partnership by default. It's important to make sure that it's the right structure for your risk appetite and growth goals. Speak to a legal consultant to make sure you vet your options and make an informed decision about forming a business entity.
Not clarifying profit and loss sharing
Financial equity and the level of investment are two important tenets of a strong partnership that should be clarified in your agreement.
"It's important for all partners in a business to feel that they are being treated fairly with respect to equity in the business," wrote Indeed. "If one partner feels they are receiving a disproportionate stake in the company or split of the profits when compared to the percentage of funding they provided for the company, it can lead to a disagreement that the partners have to resolve for the long-term health of the company."
Loss sharing is the inverse problem that should also be addressed head-on. Who bears financial responsibility for losses incurred during startup?
Ultimately, the goal of your partnership agreement is to anticipate and prevent issues before they affect the growth and success of your venture and your relationship with the partners. Consult with legal and tax experts to make sure that your agreement covers every possibility.
Capital contributions and ownership
Dedicate a section of your partnership agreement to outlining what each partner is contributing to the business partnership, whether that's cash, equipment, sweat equity, or something else. This section should include:
- Each partner’s initial contributions (e.g., money or assets each partner commits to the business).
- The methodology for how additional contributions will be handled in the future.
- Ownership percentages, including whether they are assigned based on initial contributions or other agreed-upon factors.
- How profit and loss will be shared based on ownership stakes.
In this section, outline how noncash contributions will be valued. It can be tricky to put a dollar amount or ownership stake on someone’s professional contacts or business reputation, but these intangibles are crucial. Consult with an expert who can help you assess contributions in a fair and unbiased way.
Decision-making and deadlock clauses
As your business grows, day-to-day decision-making can get complex. Write how you will handle disputes, both minor and major, to keep your business running smoothly. Your organizational structure should govern the daily decision-making that needs to happen, but more high-level decisions need to be addressed in your partnership agreement.
“Business partners with equal ownership sometimes hit a wall when they can’t agree on critical decisions. This paralysis of company operations creates deadlock situations,” wrote The Jacobs Law. “A deadlock clause (also called a deadlock resolution clause) works as your business’s safety valve — a contractual provision that sets clear protocols to resolve such impasses.”
In addition to a deadlock clause, assign voting rights to partnership members based on their capital contributions, seniority, or tenure. Create a tie-breaker system that determines who has the final say in a deadlocked issue. This could be a neutral third-party, the chairperson of the board, or an investor with the highest stake in the business, for example.
Exit and buy-sell terms
Many partnerships create a separate “buy/sell agreement” for their business. “The buy-sell agreement prevents an owner from selling their interests to an outsider without the consent of the other owners. It also provides an orderly and equitable method of determining the value of each owner's interest in the business,” wrote Wolters Kluwer.
As your business grows, it’s prudent to create a separate buy/sell agreement. However, include a section in the partnership agreement that covers what happens if a partner wants out, dies, or stops performing.
“The exit clause typically outlines notification procedures, buyout terms, transfer of interests, and other logistics,” wrote Smith, McDowell, and Powell. “Having these details mapped out ahead of time minimizes confusion and disputes if a partner departure occurs.”
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