What is a Partnership Agreement?
When choosing a business structure, you need to choose the best option for you and your business. Many businesses choose to create a partnership for their business structure. In this blog, we will explore what a partnership agreement is and how to navigate it to set your business up for success.
Partnership agreement definition
A partnership agreement outlines specific business practices for the partners of a company. The document helps establish partners’ various business responsibilities and the rules they need to follow when carrying them out. It also covers ownership and investments, profits and losses, and company management. “Partners”, in this context, refers to two people, though there's no limit to how many partners can form a business partnership.
Partnership agreements go by different names depending on where they’re formed and who forms them. Other names for partnership agreements might include:
- Articles of Partnership
- Business Partnership Agreement
- Creation of Partnership Agreement
- Formation of Partnership Agreement
- General Partnership Agreement
- Partnership Contract
Partnership agreements are created to help answer various what-if questions so that contingencies can be put in place so the company can run smoothly. The three main types of partnership agreements are:
- General: In a general partnership, all partners equally share liabilities, profits, and assets.
- Limited: Limited partnerships protect partners who do not contribute capital equally. The partner or partners who contribute the most to the business earn the most profit, but they also take on the most liability. Partners who contribute less in capital or assets earn less.
- Limited liability: Limited liability partnerships are much the same as general partnerships, but partners have limited personal liability while maintaining equal shares of the company and its profits.
Elements of a partnership agreement
Most partnership agreements look the same in one way or another. When drafting, make sure you include the following categories:
- The name of your business
- A brief summary of your business and why it exists
- All partner's names and contact information
- Details of any capital contributions (money, assets, tangible items, property, etc.) that each partner provided
- The percentage of the company that each partner owns
- The percentage of profit and loss assigned to each partner
- How the company will distribute revenue
- Outline how the partners will manage the company and how voting between partners will function in the decision-making process
- Creating specific guidelines for adding and removing partners
- Descriptions of how the business may be liquidated and how profits will be shared
- Description of how a partnership representative will manage tax filings
- Instructions for how each partner's ownership in the company should be liquidated or redistributed because of death or disability
The importance of the partnership agreement
A partnership agreement is a foundational document and is legally binding on all partners. The agreement outlines the business’s day-to-day operations and the rights and responsibilities of each partner. In this way, the document is not unlike a set of corporate bylaws.
While it’s technically possible to create a partnership without a partnership agreement, as it is not a legal requirement in most countries, it is advised. Some partners only have an oral agreement or jot down something quickly in a notebook to establish their partnership. It’s best to launch a business only after all partners sign a partnership agreement. This will protect everyone from misunderstanding and will clearly outline what everyone is doing and why. You should store the signed agreement along with other important business records.
How do you create a partnership agreement?
Not having a partnership agreement can spell disaster for lots of business owners, so you’ll want to make sure that the version you create is as good as it can be.
Consulting a business lawyer may be one of the best ways to ensure your partnership agreement is sound, especially if your agreement is complex. For example, if you have more than two partners or if your partnership has a high amount of assets, it’s probably best to get the help of a lawyer. A lawyer is best qualified to ensure that your agreement reflects in legal terms what you and your partners might have agreed to verbally.
For the partnership agreement to be legal and binding, each partner must sign it. While it’s good to have physical copies, electronic copies and signatures are just as good. You should also distribute an electronic or physical copy of the agreement for each partner to keep. Keep an extra one in storage as part of your business records.
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