When partners decide to go into business, they are happy and motivated to embark on an exciting adventure together. They usually agree on almost everything in the early part of the venture. Additionally, they believe they can run the business together for a long time. Furthermore, they have that mindset that nothing can go wrong in the process. However, in reality, these ideas are easier said than done. Whether it be family or among colleagues and friends, running a business can be a handful.
It is not just about daily business processes but also the decisions partners need to make for the business. It’s not all the time that they agree to situations. Others will negotiate and compromise. At the same time, some might lead to arguments. A partnership agreement can guide business partners in managing expectations and provide each other confidence in their business venture.
How does a partnership agreement work?
A partnership agreement refers to a legal document stating how small businesses operate with two or more people. The document lays out all the responsibilities of every partner in the firm. Furthermore, it also dictates how much each business partner owns and how much each will be responsible for in terms of profit and loss. Also, the agreement includes terms on how members will manage and address possible situations which can affect the business. These situations can include the death of a partner and how a partner can leave the company.
More importantly, the primary purpose of a partnership agreement is to write the answers to usual questions that can happen in the business. This helps all business partners handle the odds in the process.
How to create a partnership agreement?
When you look at a partnership agreement template, it may vary from one to the other. This is because each creator has their way of formulating. Here’s a comprehensive guide on how to do it.
- Specify the kind of business you are running. You can describe the business type based on the service you provide
- Input the place of business. Each state has different rules for partnerships.
- Provide details of the partnership, including the name and address of the headquarters.
- State the duration of the partnership from the date the partnership takes effect and how it will end.
- Provide all the details of each partner. Also, specify whether they are a corporation, individual, trust, LLC, or partnership.
- Provide each partner’s capital contributions like the amount of time, assets, or money each gives to the partnership.
- Outline the process of the acceptance of new partners. There must be terms and provisions for how you and your partners allow new partners.
- Create an outline of how partners can voluntarily withdraw from the company.
- Identify the terms for the dissolution of the partnership. In most cases, partners need to include the distribution of business assets in fixed percentages, equal shares for all partners, or in proportion to the capital contributions.
- Set rules and regulations for calling meetings among partners to develop critical financial and business decisions.
- Assign a managing partner responsible for day-to-day operations and overall management.
- Decide on the voting method. You can base the partner’s voting powers on capital contributions, profit share proportions, or whether you want an equal voting power.
- Identify which among the partners have signing authorities.
- Provide an outline of the decisions that need unanimous consent
- Determine the process of making significant financial and business decisions. This can either be through a majority or a unanimous vote.
- Decide on how to distribute profit and losses.
- Determine whether partners can receive compensation.
- Discuss tax elections.
- Assign a partnership representative. This is significantly beneficial during audit procedures.
- Provide a specific date at the end of the fiscal year.
- Outline what to include in an annual report. Ensure to have the federal income tax, income statement, balance sheet, cash flow report, and summary of the business’s profit and loss.
- Decide on how to resolve disputes.
- Sign the agreement
Reasons why partners should create the agreement
Being fully prepared is one of the primary reasons businesses need to have a partnership agreement. However, companies should also look into other factors on why they should get this type of document.
- Avoid the default laws of the state. With no written agreement, business owners will be stuck with following the state's default rules. Sure the state’s statutes are beneficial, but some owners would opt for more control. Furthermore, the partnership agreement allows businesses to vary the rules in their best interest.
- To take better control over who owns the business. The agreement will also discuss the terms on sales and transfers in a business to control who owns the company. Without a written agreement, an owner can quickly sell interests to anyone, including competitors. The provisions stating who, when, and whom company interests may be transferred or sold can prevent unfortunate situations. If partners draft the document perfectly, the terms can guarantee owners will retain their company’s percentage stake and eventually protect them from unwelcome partners.
- To discuss and agree on essential concerns ahead. Important decisions such as dispute resolution should be present in the partnership agreement. Without this placed into writing, there is no way to enforce arbitration or mediation, causing time-consuming and costly litigation.
- To remove non-performing or disruptive partners. While a partner may form a business with good intentions, the reality sometimes does not coincide with those intentions. In the long run, owners who were closest family members or best friends may grow apart and eventually commit acts that can endanger the company. The partnership agreement welcomes terms and processes in removing such partners and reclaiming their interests before they can jeopardize the business.
- To protect the company and investments. The document must also include provisions addressing the things to do in case of the owner’s disability, death, or bankruptcy. All the mentioned events can somehow affect the company’s image. With no written document, owners might be forced to dissolve the business, putting investments at risk.
Other things you must know about partnership agreements
- It is ideal for each partner to have their lawyers. With technology today, you can easily refer to a partnership agreement example online. While you can do that, not all partnership agreements are the same and created equal. Consequently, if a business partner hands in the document, it will be beneficial to let your lawyer look at it.
- There must be a clear outline of every partner’s roles and responsibilities. Partners need to be accountable for their roles in the partnerships. Without specified functions, they may forget to do their tasks accordingly in the long run. In some cases, one partner finances the business while the other manages the company. Either way, all roles must be clear to avoid confusion.
- The agreement should have an exit strategy. Partnerships do not guarantee to last forever. New ventures and opportunities might lead partners to part ways from the agreement. A few of the aspects to address are the calculation of the financial interest in the business, payment methods, and whether the partner can immediately start a business that directly competes with the previous company.
Q1: Where can I find a partnership agreement sample?
A1: As you check online, you can easily select a partnership agreement template. Remember that they vary in structure and form. In most cases, templates allow you to edit the document, so making it your own is straightforward.
Q2: Why does a partnership agreement need to be in writing?
A2: While it may not be necessary for partnerships to be put into writing, it can still be wise to cover significant concerns related to business in the form of a written document. Remember that partnerships involve investments and shares in profit and loss, so organizing and setting provisions for these aspects can make the partnership run smoothly.
Q3: How do partnerships pay taxes?
A3: The partnerships report profit and loss to the IRS using a particular form. Being a partner, you generate income from profit shares, and you need to report that income under your personal taxes.
Q4: What is a partner’s liability regarding the partnership’s business obligations?
A4: All partners are individually liable for all business obligations. This means that if the business fails and the partnership cannot afford to pay debts, creditors can go after their personal assets like cars, homes, bank accounts, etc.