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What is a partnership agreement?

This is a written agreement between two or more parties that details the business relationship of the people involved. This is an important agreement for partners in order to avoid conflicts and unwanted legal proceedings down the road. This legal agreement should include details such as the nature of the business, the responsibilities of the partners, the rights of the partners, and the rules of the business.

The agreement should be completed before the parties begin working together on a business. This will ensure that they are aware of their responsibilities and also so that a contingency plan will be in place.

If you want to set up an agreement for a small business idea, get all the information you can about your idea beforehand. Remember that this agreement will need to be signed by all parties. To ensure you have a legal agreement, consider asking for legal counsel and a witness to sign the agreement as well.

Other names

  • Articles of Partnership
  • Business Partnership Agreement
  • General Partnership Agreement
  • Partnership Contract

Who needs a partnership agreement?

Any group of people who are running a for-profit business together should have one.  This agreement serves as the operating agreement for your company. It sets out rules and guidelines for business partners to follow so that they can avoid future conflict.

Most common partnership situations

Any group of individuals who are forming a business together should have an agreement.  A partnership can consist of friends, family, or strangers that meet online.

When is this agreement needed?

Any arrangement between different individuals to form a business creates a partnership.  There is no formal process needed to create a partnership. A agreement between these parties clearly sets out the goals, rules, and responsibilities of the parties in the partnership.

Consequences of not using one

If you do not use an agreement, your state’s default laws regarding partnerships will apply.  If you want to establish your partnership in a different manner, an agreement will allow you to do so.

If you do not have an agreement that clearly sets out each partner’s ownership interest and capital contributions, each party will be assumed to have an equal interest.  This means that each party is assumed to own an equal part of the partnership even if only one party contributed the majority of funds to the partnership.

Failure to have a valid agreement may also subject you to additional tax liability.  A partnership is considered a “pass-through” entity for tax purposes, which means that profits and losses pass through the business directly to the individual partners.  If there is no set agreement about ownership share in the partnership, the state will assume that the partners share equal tax liability, regardless of who contributed what to the partnership.

Types of Partnerships

  1. General Partnership - Each partner has equal rights and responsibilities and can act on behalf of the partnership as a whole.  Each individual shares in the profits and losses. Individual partners are personally liable for the actions of the partnership - this is known as joint and several liability.
  2. Limited Partnership - Consists of general partners and limited partners.  General partners manage the business and have the same rights and responsibilities as partners in a general partnership.  Limited partners, who are also called silent partners, contribute money only. They are not involved in the day-to-day management of the partnership.
  3. Limited Liability Partnership - In a limited liability partnership, none of the partners are personally responsible for the actions of the partnership.  This is a more formal business structure that requires a written agreement and registration with the state. Some states limit this type of partnership to professional organizations, such as accountants and attorneys.

Pros and Cons of different types of agreements

Pros of General Partnership: Smaller start-up cost, less paperwork, simple taxes

Pros of Limited Partnership: Limited liability for limited partner, more attractive to investors, tax benefits

Pros of Limited Liability Partnership: Limited liability for all partners, flexibility, no double taxation

Cons of General Partnership: Joint and several liability, shared management, not attractive to investors

Cons of Limited Partnership: Joint and several liability for general partner, additional paperwork, divided authority

Cons of Limited Liability Partnership: Must comply with state filing requirements, use limited in some states, tax limits in some states.

Legal Considerations

If you’re going into business with someone, it’s a good idea to set the details of the arrangement in writing.  When you are writing the agreement, you should keep some legal issues in mind.

Who’s really pulling the strings?

There are two main bodies that dictate the workings of a business partnership. To wit – the laws of the state in which the agreement is made and the rules laid out in the official document. Surprisingly, you don’t need to base your agreement’s tenets entirely upon the governing state’s laws. The rules laid down by partners generally supersede those rules enforced by the state. This means you have relatively free rein when it comes to many key elements, such as divisions of profits, assets and responsibilities. However, any issues not concretely outlined in the agreement are automatically seen as reflecting the laws of the state.

Why should you put your partnership agreement in writing?

The short answer here is “see above.” If you don’t put your agreement in writing, the state gets to control it in its entirety. If things go awry, both parties have no control over the outcome. What’s more, it makes it more likely that things will go awry, as you have not drawn up the rules of partnership yourselves. In business arrangements, and in fact many areas of business, it is always best to err on the side of micromanagement.

What should you put in writing?

There are three basic types of business partnership. The first is called a “General Partnership.”  It runs on a majority vote and holds all members proportionally or equally viable. If you want to follow a different model that protects some partners from liability, like a Limited Partnership or an Limited Liability Partnership, you’ll want to take the time to draw up an agreement.

A partnership agreement should cover the following bases –

Decision-making procedures

Will business decisions be made by a majority vote? Will you elect one partner to make decisions? Will each partner be able to vote equally or will level of investment govern level of control. It may seem fair to divide power equally, but then having an even number of partners presents the risk of attrition. Keep this in mind when drawing up your agreement.

Division of interest among owners – Often this is equal, but it does not have to be.

Withdrawal procedures – Are there circumstances where a partner can be forced into an involuntary withdrawal? How will the price of one owner’s shares be figured if he or she withdraws? How will payments work for his or her share? This is a particularly important decision to make, as the financial backlash of withdrawal can get quite ugly in court.  

In sum, it’s worth getting your agreement down in writing, either by digging up a free partnership agreement template on the internet, writing it from scratch, or seeking legal advice.

Partnerships and tax obligations

Federal law allows the Internal Revenue Service (IRS) to treat partnerships as taxable entities and audit them at the partnership level.  This means that the IRS may choose to audit the partnership as a whole.

Your agreement should address tax elections and select the partner who will represent the partnership for tax purposes.

How to dissolve a partnership agreement

Partners may decide to dissolve a partnership because: there is a specified end date for the partnership, the purpose of the partnership has been completed, death of a partner, bankruptcy of a partner or the partnership, a partner chooses to withdraw.

An agreement can specify whether partners may withdraw and what that partner has to do to withdraw.  

An agreement should specify how they would like assets distributed in the event of partnership dissolution.

What to do along with creating a partnership agreement

Each jurisdiction has different rules and regulations regarding partnerships.  You should check with your state and local commerce departments to determine if you are required to register your partnership.

Sample Partnership Agreement

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Sample Partnership Agreement

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