Going into business with a partner offers numerous benefits. You will double the resources you can put into your startup regarding money, time, and creativity. Having another person to bounce ideas off can help when brainstorming everything from product concepts to marketing plans. Partners can also push one another, ensuring that you don’t get stuck in a rut, and encourage one another to take greater risks — while serving as a restraint to ensure they aren’t risking too much.
Your ideal business partner will provide balance. Their strengths will balance your weaknesses and vice versa. Last but not least, having a business partner can make going to work every day more fun! You decided to start a business because you wanted to pursue your passion and establish a career you love. Going at it alone can be stressful at times. Having a partner by your side offers security and can make entrepreneurship more enjoyable.
Given the benefits, it’s no surprise that general partnerships are among the more popular types of legal business entities. However, it’s also important to recognize the risks of a business partnership. The partners share business success and profits. They also share liabilities. Disagreements can arise, especially when it comes to an entrepreneurial endeavor that both people are passionate about.
A written partnership agreement is a valuable protective measure that ensures potential disputes are resolved efficiently and fairly. This guide provides greater detail on what a business partnership is, why it’s so important, and what should be included in one.
What is a partnership?
A general partnership is a type of business entity where two or more people jointly own a business, sharing in all profits, assets, and liabilities (financial and legal). There are some pros and cons to this type of arrangement. A general partnership is easy to establish and dissolve. Additionally, it simplifies taxation: Each partner is responsible for their own tax liability and must declare any partnership earnings on their personal income tax return.
There are drawbacks to a general partnership. In a general partnership, the partners involved agree to joint, unlimited liability for business debts. Additionally, partners are liable for one another.
Why do you need a business partnership agreement?
A partnership agreement details each partner’s ownership stake and authority in business operations and essential details, like how profits and losses are divided. Additionally, a partnership agreement includes the steps that need to be taken if the business partnership or business entity is dissolved.
Basically, this legal document addresses possible points of contention in the business partnership and outlines how to solve them. Without a business partnership agreement, you face a number of risks. We detail some of the scenarios you might face below.
State Default Rules
Without a written partnership agreement specifying who owns how much of the business, state default laws will apply. Most states have some form of the Uniform Partnership Act (UPA) or revised Uniform Partnership Act, which usually assumes that all partners involved have invested an equal amount of resources and time into the business. The law thus dictates that profits and losses should be split equally. However, not all partnerships are 50/50. Sometimes, one partner will invest more money.
Company Ownership Control
The business partnership agreement should specify who owns how much of the business and what they are and aren’t allowed to do with that ownership stake. Say your business partner wants to quit and unload their stake in the business. Theoretically, they can sell their ownership interests to anyone — including a competitor. Your business partnership agreement can ensure this doesn’t happen.
One of the most important benefits of a business partnership agreement is its ability to settle disputes. If you and your business partner are in a deadlock about an important topic, you can turn to the agreement for guidance on how to solve it. The agreement could mandate that you must attend mediation, for example. This can help you avoid the stress and expense associated with more costly procedures, like arbitration or (in the worst-case scenario) litigation.
Ability to Remove a Partner
If a business partner performs in a way that undermines or threatens the business’s success, it may become necessary to remove them from the partnership. Otherwise, they may do permanent damage to the company. The partnership agreement should outline under which circumstances a partner can be removed and how the partner can be removed. For example, what happens to their stake in the company?
If a business owner dies, becomes disabled, or faces personal bankruptcy, what happens to their investment in the company? For example, in the event of the death of a partner, can their stake transfer to a spouse or child? Or does it have to go to people who are actively involved in the business? This is often linked to a person’s estate planning and is thus also important for partners to determine personally.
Majority and Minority Owner Protection
For many business owners, the goal is to sell their company for a profit. A written partnership agreement should include provisions that protect minority and majority partners in case of a third-party buyout. This is critical in uneven partnerships, where one individual has invested more resources than the other. A minority partner has a less-present role in day-to-day business operations — but they still have certain rights in running the company, which need to be clarified.
What should a business partnership agreement include?
No two business partnerships are identical. Your document must be tailored to your company and partners and the unique terms you’ve decided on. That said, all business partnership agreements should cover a few critical points. Here’s a brief overview of what to include. However, this is not an exhaustive list, and you may need to add points depending on your business’s needs. A law firm specializing in business legal services can help.
Your business partnership agreement must include the official name of the partnership. This is the name you’ll use for all legal business purposes (for example, contracts). The name could be a combination of the individual partners’ last names. Alternatively, you can use a fictitious business name. This needs to be formally registered.
Guidelines for fictitious name registration vary between states. The terminology can vary, too: In some states, a fictitious business name is called a “doing business as” (DBA) or trade name. In most states, a fictitious name must be unique. You’ll have to check whether another business is using the name in the state, complete an application, and possibly pay a filing fee.
This is one of the most important parts of the agreement. You and your partner(s) must agree on who will contribute how much to the business, whether it’s property, cash investments, or services. You must also agree on how much ownership interest each partner will have.
Ownership percentage usually aligns with how profits and losses are distributed, so capital contributions are important to agree on. This can be a common point of contention between partners and lead to major disputes down the line if you don’t figure it out now.
Once contribution and ownership are determined, the next step is to determine how profits, losses, and draws will be allocated. As mentioned, this is often aligned with the ownership percentage. So, if a person has 70% ownership, they will get 70% of the profits, for example.
You can determine whether profits and losses will be based on each partner’s interest in the company. You should also decide if each partner will be entitled to withdraw allocated business profits (also known as a draw) or whether profits will be distributed at year’s end. Again, these can be touchy topics to discuss, especially if partners have different financial needs.
Partner Authority and Decision-Making
Once a person is established as a partner, they are technically allowed to bind that partnership — for instance, to a debt or a contract. They can take this action without consulting the other partners. This is the standard rule that applies unless you say otherwise in your partnership agreement. You can mandate that partners have to get consent from one another first.
You should also explain the decision-making process in the partnership. For example, you might require that major business decisions (e.g., bringing on a new partner or selling to a competitor) require a majority vote. Your business agreement should thus also define what is considered a major versus a minor decision.
It’s smart to figure out some basic management guidelines before your business commences operations. For example, decide on essentials, like who will handle the bookkeeping, provide customer service, or manage employees. There are also external relationships like suppliers to consider.
Your current partnership arrangement isn’t set in stone. Make provisions for how the partnership can change. For example, what if a partner leaves or a new partner comes on board? Additionally, determine how disputes among partners will be resolved. Again, defining this in the partnership agreement can help prevent costly dispute resolution measures like litigation.
Start preparing your business partnership agreement
Starting a business is exciting. Starting a business with a partner can double that excitement. It might seem like a business partnership agreement is raining on your parade. After all, who wants to think about potential issues, like disputes with a partner? This is a must-have document if you’re planning to go into business with someone, however. Taking care of it now will save you stress in the long run. Think of it like insurance: You hope you don’t need it, but if you do, it’s good to have!
ZenBusiness is dedicated to helping small business owners find success. Our resources provide tips on everything from forming a limited liability company (LLC) to obtaining a fictitious business name. Visit us today to get the tools you need to start, manage, and grow your business.
Business Partnership Agreement FAQs
Are you still confused about business partnership agreements? We answer some of the most common queries below.
- How do you structure a 50/50 partnership?
A 50/50 business structure is an equal partnership. Each person has the same say in business management and operations. Both partners need to consent and contribute to a 50/50 arrangement. You can help prevent conflict by communicating clearly. Discuss basics like salaries, how much time each partner has to commit to the business, and overarching visions for the business. You may want to consult an attorney for legal advice.
- Is a business partnership agreement legally binding?
For a business partnership to be legally binding, each partner must be assigned specific roles, responsibilities, and financial expectations. It’s also imperative to outline expectations for plans for the business.
A legal partnership is technically created as soon as two separate people start performing defined work roles together. However, you can further protect your partnership by formally registering it, such as a general, limited, or limited liability partnership.
- What are the types of business partnership agreements?
You can establish a limited liability, limited, or general partnership agreement.
In a general partnership, all partners have the same amount of agency in business decisions. This is the default standard assumed by most state laws. In a limited partnership, some partners have more control over decisions than others. Some partners may be “silent” and not have any control over daily business decisions. In a limited liability partnership, financial responsibilities and business duties are divided between silent partners and owners. This setup is similar to a corporation in that it may protect some partners from legal liability.