Choosing a business structure is one of the first and most important business decisions you make. The type of entity you choose affects what business taxes you owe, your profits and losses, and the level of control you have in your company.
If you decide to start a business with at least one other person, you might consider forming a partnership. Make sure you have a partnership agreement in place if you choose this business structure.
What is a partnership agreement?
A partnership agreement is a contract that defines each partner’s role, liability, and profit distribution. Creating a partnership agreement ensures you and your partner (or partners) have a solid plan to refer to during conflict. Because it is a legally binding document, you should consult a lawyer before drafting your partnership contract.
You are not required to create a partnership agreement. Some partners decide to enter into a partnership with a verbal agreement or handshake. However, if you do not create a partnership agreement, you must follow your state’s partnership laws.
Partnership agreements vary from business to business. You will create a general partnership agreement or limited partnership agreement, depending on the type of partnership you form.
General partnership agreement
General partnerships are businesses owned by two or more people who have an equal share in profits and losses. Both partners are general partners, meaning they are responsible for managing and making business decisions.
Although not required, a general partnership agreement can keep your business running smoothly.
General partnership agreements might lay out details like your exit strategy for small business, responsibilities, and conflict resolution steps.
A business partnership agreement is also beneficial if both partners agree there will be an unequal share of profits and losses.
Limited partnership agreement
There is at least one general partner and one limited partner in a limited partnership. The general partner assumes business risks while the limited partner is not liable for anything past their investments.
In a limited partnership agreement, general partners are responsible for making decisions and handling daily operations. Limited partners contribute money but do not manage day-to-day operations.
If you form a limited partnership, you should have a written document listing out partner details. A limited partnership agreement is especially crucial because partners have different levels of involvement, liability, and profit share.
What to include in a small business partnership agreement
Before starting your partnership, create your partnership agreement. Your partnership agreement should name your business and provide details on what your small company will do.
Although there is no standard partnership agreement structure, your document should also include the following information.
Clearly define how much each partner will contribute to the business (money, equipment, etc.). Generally, your contribution amount determines how much ownership you have in the company.
Contributions extend beyond tangible assets. Define how much time you and your partner will devote to getting the business off the ground. Include any related information in your partnership agreement.
Failing to detail your contributions could lead to conflict. You might think your partner isn’t pulling their weight, or vice versa. You need an outline holding you and your partner to your contribution promises.
2. Profits and losses
Include information on what each partner is entitled to. Partners receive distributions from the business’s profits instead of salaries.
You may receive a different distribution amount than your partner, so be clear about who gets what in the agreement. For example, if you have a greater stake in the business because you contributed more, you might receive a higher percentage of the profits.
Consider what you and your partner will do if your business’s profits are low. Will you and your partner still pay yourselves? Include this in the partnership agreement.
Also, do you plan on putting a percentage of business profits back into your business? Detail information about reinvesting earnings in the partnership agreement, too.
3. Partner roles
Your partnership agreement should talk about what responsibilities and authority you and your partner will have.
When you have a partner, you can split up some of your small business owner responsibilities, like running payroll, maintaining your accounting books, hiring employees, and marketing. Decide who will do what and document it.
Also, decide how much authority you and your partner have when it comes to making business decisions, like purchasing goods or signing contracts.
4. Partnership changes
Businesses don’t stay stagnant. You and your partner should be prepared to handle changes in your company.
When you experience business growth, you might decide to add new partners. Or, you or your partner may choose to leave the business. How will you handle changes in your partnership?
Because you and your partner won’t run your business forever, you need to outline your exit strategy. Will you sell your business to your partner, a family member, or a stranger when you retire? Of course, this could change as your partnership progresses. But, you should still have an idea for your business’s endgame.
5. Conflict resolution
When two or more people work together, conflict is unavoidable. If you and your partner have different opinions, how will you come to a decision?
Sometimes, a conflict between partners turns ugly. If you and your partner cannot resolve your disputes, you could have a lawsuit on your hands.
To help avoid lawsuits, consider conflict resolution options. Your partner might be in charge of some decisions while you spearhead others. If you have more than two partners, you could put decisions to a vote. Or, you could pursue other conflict resolution strategies such as mediation.
Once your partnership is up and running, be sure you maintain accurate accounting books. Patriot’s online accounting software makes it easy to track income and expenses. And our free, U.S.-based support is only a call or click away. Get your free trial today!
This article is updated from its original publication date of September 4, 2018.This is not intended as legal advice; for more information, please click here.