Partnerships can be complex depending on the scope of business operations and the number of partners involved. To reduce the potential for complexities or conflicts among partners within this type of business structure, the creation of a partnership agreement is a necessity. A partnership agreement is the legal document that dictates the way a business is run and details the relationship between each partner.
Although each partnership agreement differs based on business objectives, certain terms should be detailed in the document, including percentage of ownership, division of profit and loss, length of the partnership, decision making and resolving disputes, partner authority, and withdrawal or death of a partner.
- Many small businesses are organized as partnerships, which require formal documentation before being established.
- The partnership agreement spells out who owns what portion of the firm, how profits and losses will be split, and the assignment of roles and duties.
- The partnership agreement will also typically spell how out disputes are to be adjudicated and what happens if one of the partners dies prematurely.
Percentage of Ownership
Within the partnership agreement, individuals commit to what each partner is going to contribute to the business. Partners may agree to pay capital into the company as a cash contribution to help cover startup costs or contributions of equipment, and services or property may be pledged within the partnership agreement. Typically these contributions dictate the percentage of ownership each partner has in the business, and as such as are important terms within the partnership agreement.
Division of Profit and Loss
Partners can agree to share in profits and losses in line with their percentage of ownership, or this division can be allocated to each partner equally regardless of ownership stake. It is necessary these terms are detailed clearly in the partnership agreement in an effort to avoid conflicts throughout the life of the business. The partnership agreement should also dictate when profit can be withdrawn from the business.
Length of the Partnership
It is common for partnerships to continue operations for an unspecified amount of time, but there are instances where a business is designed to dissolve or end after reaching a specific milestone or a certain number of years. A partnership agreement should include this information, even when the time frame is unspecified.
Decision Making and Resolving Disputes
The most common conflicts in a partnership arise due to challenges with decision making and disputes between partners. Within the partnership agreement, terms are laid out regarding the decision-making process that may include a voting system or another method to enforce checks and balances among partners. In addition to decision-making procedures, a partnership agreement should include instructions on how to resolve disputes among partners. This is typically achieved through a mediation clause in the agreement meant to provide a means to resolve disagreements among partners without the need for court intervention.
Partner authority, also known as binding power, should also be defined within the agreement. Binding the business to a debt or other contractual agreement can expose the company to an unmanageable level of risk. To avoid this potentially costly situation, the partnership agreement should include terms relating to which partners hold the authority to bind the company and the process taken in those cases.
Withdrawal or Death
The rules for handling the departure of a partner due to death or withdrawal from the business should also be included in the agreement. These terms could include a buy and sell agreement detailing the valuation process or may require each partner to maintain a life insurance policy designating the other partners as the beneficiaries.