After you have chosen the perfect business partner, it is essential that you cover all your bases when you set up your partnership agreement. If you can afford an attorney, it is a good idea to have one draft of the agreement. At the very least, you should hire an attorney to review the partnership agreement before you sign it to ensure your interest is covered.
What Is The Purpose Of A Partnership Agreement?
This agreement has many purposes but the two most important purposes are dispute resolution and the business structure. Even the best relationship has disagreements especially when there are a lot of decisions that need to be made. When your partnership agreement is crafted carefully, it will outline exactly how disputes will be handled before they happen, instead of in the heat of the moment.
In addition to providing dispute resolution, the partnership agreement forces the partners to think about how the business is going to run and be structured. This can minimize potential misunderstandings and get everyone on the same page from the beginning.
Critical Elements That All Business Partnership Agreements Must Have
Business Name: The name that the company will be operating under.
Purpose: A broad statement of the business’s purpose. Leaving the purpose broad will provide flexibility for the company to adapt over time.
Workload Structure: The partnership agreement should include how the workload will be shared. The following questions will help you determine what should be included regarding the partners’ workload:
Will the partners be expected to have set work hours?
Will all of the partners be working the same amount of time? Or will one partner work less or more than the others?
How much vacation time will be given to each partner, each year?
Will each partner’s role be full-time or can the partner conduct another type of business outside the company?
If yes, what another type of business that is allowed to be conducted?
Partner Contributions: Determine exactly what each partner will be contributing to the business such as cash, physical property (office space, equipment, etc.), and intellectual or other property types (client lists, software codes, etc.). After you have all contributions listed, discuss with the other partners what restrictions there will be on those contributions, if any. The following are some examples of the types of things that should be discussed:
Client Lists: Does all of the revenue from the clients that a partner brought to the business flow to the business? Or does a percentage of the revenue, from those clients, flow to the partner directly?
Personal Property: If a partner brings the property into the business (such as a copy machine, computer or lawnmower) does the property become the business’ property?
Intellectual Property: If a partner brings the intellectual property into the business (such as a software code), does the business own it? Are the other partners allowed to modify it?
Partners’ Compensation: All partnership agreements should list the terms of each partner’s compensation. The following questions should be discussed to determine what should be included regarding compensation:
Will each partner receive a salary? If yes, how much will they receive and when will it be disbursed?
If a partner receives less salary, will the difference be made up for in the future?
Will the profits be reinvested in the business?
If yes, when will profits be taken out?
How will profits be divided up between the partners?
How will business losses be handled?
Ownership: Now that you have determined the contributions, workload, responsibilities, and compensation, you need to agree on how exactly the ownership should be split. This is a difficult calculation and can cause problems between partners before you even finalize the partnership agreement. Things to consider:
Business Authority: The partnership agreement should state the authority that each partner has. The following questions need to be answered:
Does each of the partners have the authority to enter into contracts (sign) on the business’ behalf
Will the business have a line of credit? Depending on the structure of the business that is chosen, all partners may be held personally liable for the business’ credit
Can each partner make purchases for the business without first consulting the remaining partners? In general, there is a monetary limit set. The partners must first get the other partners’ permission if the purchase is above the set limit.
Death Or Disability: The partnership agreement should state what happens to the partnership if one of the partners dies or if they become disabled and are unable to participate at the same level. To prevent heirs of the deceased partner inheriting a portion of the partnership, partnership agreements normally include a buy/sell agreement.
Partner’s Exit: The agreement should state the terms of a voluntary and involuntary exit. The following questions need to be addressed:
What will happen if a partner would like to leave the business to pursue other interests?
What circumstances would a partner be able to be forced out of the partnership?
Dispute Resolution: Even in the perfect partnership, there will be times where the partners are unable to agree about a topic. The partnership agreement should state how disagreements will be handled. That way, when an issue arises, you will know exactly what the determining factor will be. There are many ways disputes can be handled including:
One of the partners has the final say on a portion of the business.
The vote is based on the percentage of ownership
Partners use an external advisory board to resolve any disputes
Partners use a mediator to resolve any disputes
Partners agree to arbitration, mediation or litigation in extreme cases
New Partners: The partnership agreement should include the process of bringing a new partner in. How will it be decided? Majority vote?
Selling The Business: What are the exact circumstances that the business can be sold? This will probably be included in the Buy/Sell Agreement.