Establishing a business partnership is a popular option for those venturing into a small business enterprise. Partnerships are easy to set up and terminate and do not require complex tax filing systems. However, business partnerships have certain drawbacks such as personal liability and unprotected personal assets.
If you are considering forming a partnership, it is wise to consult with a business attorney to identify which type of partnership would be best for your situation. An attorney can also help you draft an effective business partnership agreement, among other things.
What is a Partnership Agreement?
A business partnership agreement is a written agreement between two or more individuals undertaking a for-profit business as partners. Generally, the agreement outlines the business nature and objectives of the partnership, the individual contributions of partners, and their specific rights and responsibilities. Other terms that are often outlined in a partnership agreement include:
- Length of the partnership
- Capital contributions
- Profit and loss distributions
- Partner authority or binding power
- Decision-making and dispute resolution processes
- Financial reporting and taxation methods
- Termination of the partnership
While a valid partnership can exist without a written agreement, creating a written agreement reduces potential disagreements or conflicts among the partners. Indeed, a comprehensive business partnership agreement is beneficial to all partners and the business itself.
The Benefits of a Business Partnership Agreement
In order to avoid ambiguity and disputes, the terms in a business partnership agreement should include as much detail as possible. An agreement can keep partners on the same page and help resolve any potential disputes. With a well-crafted business partnership agreement, all partners are assured of the future of their business venture.
Below are seven benefits of a partnership agreement.
1. Avoiding the state’s default rules on partnership.
Although a valid partnership can exist without a written agreement, in the absence of a written agreement the business partnership falls under the general provisions of the state statutes governing partnerships. However, the default rules of the state can limit control and may lead to the inequitable distribution of profits, liabilities, assets, or debts.
A written agreement avoids potential inequity by allowing partners to dictate the rules of partnership to serve their best interests.
2. Clarifying management duties.
Under the general provisions for partnerships, any partner is legally allowed to make a decision regardless of whether the other partners approve. These legally binding decisions may put partners and the entire business at risk.
An agreement prevents partners from making decisions without approval by setting limits on which partners have authority over certain decisions. The agreement details each partner’s level of authority, decision-making power, specific responsibilities, and management duties. Clearly outlining the roles of each business partner reduces confusion and disagreements.
3. Establishing decision-making processes and voting rights.
In the event that disagreements arise, it is important to establish voting rights at the outset. For example, if only two partners are part of the business, a trusted associate may be delegated with a vote that can break a 50-50 deadlock. Voting rights may also depend on how much a partner has contributed to the business. Whichever the case, it is important to establish clear guidelines for decision-making.
4. Reducing money-related disputes.
As a rule, partners equally share in the profits and liabilities. This equal division can lead to disputes, especially when some partners invest more time and money into the business than others. A well-written partnership agreement can help to minimize money-related disputes.
A partnership agreement outlines specific details about financial contributions and entitlements. Profit-sharing can be made more equitable by basing it on contribution to startup costs, ongoing expenses, and other factors. Outlining these terms is particularly important in cases where certain partners invest more time and money in the business.
The agreement also limits personal liability, setting boundaries on each partners’ level of liability, depending on the amount invested. These provisions can help to minimize disagreements regarding finances.
5. Controlling ownership through an entry plan.
Shares can typically be sold to anyone, including the competition. Business interests can also be passed on to family members. To protect existing partners from unwelcome new partners, it is important to outline an entry plan.
A partnership agreement sets reasonable restrictions on the transfer and sale of interests in a company. It controls who owns the business and enables partners to retain their percentage stake. It also specifies the circumstances by which a new partner can enter the business, such as through unanimous vote.
6. Establishing an exit plan.
By default, any partner can dissolve the partnership without prior notice. The partnership is also automatically dissolved when any of the partners leave the business, die, or become bankrupt.
A partnership agreement clearly defines an exit plan for each partner. It stipulates the manner in which partners can leave the business. It also defines circumstances by which one partner can expel another in case they are not fulfilling their end of the agreement. Furthermore, it offers a plan for the dissolution of the business if all partners want to end operations.
7. Avoiding costly legal proceedings.
Although legal fees involved in drafting a business partnership agreement can add to your startup costs, this cost is much smaller than the hefty legal fees you may need to pay if a dispute arises in the future. To avoid costly legal proceedings, a partnership agreement can outline alternative dispute resolution methods such as negotiation, arbitration, and mediation. Alternative dispute resolution allows business partners to settle their disputes without the time and expense of traditional litigation.
The Importance of a Well-Drafted Partnership Agreement
Entering into a business partnership is a significant step in the growth of your business. A well-drafted partnership agreement can help you define the terms of the partnership and avoid future disputes. It is important to retain an experienced lawyer to help draft your business partnership agreement in order to protect the interests of the business and its partners.
Guest Article by:
Sally Kane is an attorney, professional writer and content director for PaperStreet, a digital marketing agency for law firms. She has been writing on business and marketing topics since 2004. Connect with her on Twitter @sallyannekane.