Details of a Partnership Agreement

By Jeffry Olson, J.D.

Details of a Partnership Agreement

By Jeffry Olson, J.D.

Many businesses choose to operate as partnerships because they're easy to form and, when compared with corporations, don't require much paperwork. This lack of official paperwork can be a huge bonus as long as the business does well. However, one of the major drawbacks of a partnership is that it doesn't provide liability protection. If the business runs out of money, the owners are liable for its debts. If the partnership runs into trouble of any kind, having some official paperwork, such as a partnership agreement, undoubtedly helps.

Businesspeople shaking hands in front of contract lying on table

State law doesn't require partnership agreements. However, drafting a partnership agreement clears up any possible confusion and avoids future conflict. Drafting the agreement when starting the business is easier because the parties are more likely to agree on its terms and are probably more open to compromise. It might be too late to draft the agreement after problems arise.

What to Put in a Partnership Agreement

Good partnership agreements include procedures and guidelines for many eventualities, and they have many provisions in common. Common sections of an agreement include information regarding contribution of capital, decision-making processes, salaries and distributions, instructions on what to do in the event of a death or incapacitated owner, and what steps to take if the partners wish to dissolve the partnership.

Contribution of Capital

This provision details how much capital each party contributes to the partnership. It should also include what happens if the original capital is not sufficient for the partnership to continue. Do the parties contribute more money or seek outside financing? If one party contributes more of the money originally, anticipating the other party does the majority of the work, this should be clear in the partnership agreement.

Decision Making

Agree on how to make all major decisions. Does one party act as the manager of the business? Frequently, partnership agreements provide that, without unanimous consent, an issue or possible plan cannot go forward. The partnership should also consider limiting the ability of one party to bind the partnership to any future agreements.

Salaries and Distributions

The partnership agreement states how to distribute profits between the partners. It should clarify whether the business repays initial capital contributions. The agreement should also state whether the business should use profits to expand or pay surplus funds to partners. Regular salaries might appear in a partnership agreement. Further, consider how to cover losses between the partners.

Death or Incapacity

The partnership agreement should address the issue of death or incapacity of one of the partners. Consider whether the partnership would continue and if an heir can step in and proceed with the business. Do the parties wish to allow the survivor to continue the business as a sole proprietorship? These decisions might extend beyond the partnership agreement, requiring the parties to consider estate-planning issues and tax consequences. Life insurance or disability insurance for the partners might also be appropriate.

Dissolution

In the beginning, as you form the business, discuss how to dissolve the partnership. Do not leave this conversation for when dissolution appears imminent. One of the partners might eventually want out of the business, possibly because of retirement or a desire to move on to other ventures. The partnership agreement should detail an exit strategy that allows the business to continue after the exit of one of the partners. Dissolution may also be necessary if the partnership is no longer profitable. Consider the price of a future buyout, and include a procedure for assessing the value of the business. When you decide on these details in advance, it avoids conflict and possible litigation in the future.

Partnership agreements are not a legal requirement, but they can help you avoid confusion and disputes. Effective partnership agreements include provisions regarding contribution of capital, decision making, salaries and distributions, death or incapacity of the parties, and dissolution of the partnership. These documents encourage teamwork, longevity, growth, and profitability of the business.

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