A partnership is an arrangement in which two or more individuals share the profits and liabilities of a business venture. Various arrangements are possible: all partners might share liabilities and profits equally, or some partners may have limited liability.
Creating a partnership agreement and setting up the proper entity/structure for the partnership are the two most important steps in the partnership process. Understanding the mechanics of how your business will be managed is the key to designing your partnership agreement and documenting the terms. Here are top things to consider in any partnership agreement.
1. Partner Roles in Signing and Authorizations.
You should have a very clear understanding of what the managers or officers of the business are authorized to do on behalf of the company.
2. Duties and responsibilities of each partner.
It is very important to outline each partner’s responsibilities and duties so each partner knows what to expect from the other.
3. Contributions of capital.
What amount of time, money, and assets is each partner contributing to the partnership? This includes the initial contributions as well as additional contributions that may be necessary to continue operating the business in the future.
4. Rights to distributions, profits, compensation, and losses.
Any right of the partners to receive discretionary or mandatory distributions, which includes a return of any or all of their contributions, needs to be clearly and specifically set forth in the partnership agreement.
5. Unanimous vote requirements.
Which events or decisions will require a unanimous vote of the business partners? It’s crucial that you and your business partners decide the procedure together from the outset.
6. Dissolution or exit strategy.
The partnership agreement should indicate the events upon which the partnership is to be dissolved and its affairs wound up. It’s possible the business concept and model don’t lend themselves to answering this question. But, for example, in a real estate deal, it’s important to have a timeline and possible triggering events that will lead to either selling the property or buying out one of the partners if they don’t want to stick around for the long haul.
7. A buy-sell provision or separate buy-sell agreement.
This type of agreement addresses major changes in the partnership arrangement. For example, what if one partner voluntarily or involuntarily leaves the partnership? How are they bought out? What happens if you want to sell your ownership interest—should your business partner have a right to buy it before you sell it to a third party? What if your business partner dies? Or gets divorced? Or files for bankruptcy? Or just wants to retire?
8. Expulsion provision.
Carefully consider this provision, which is a double-edged sword. The benefit of such a provision is that you can put in writing when a partner can be forced out of the business. For example, you and your partners could agree that if one partner isn’t pulling their weight, they can be forced out. But be certain your well-deserved, three-week vacation to Tahiti doesn’t trigger the expulsion clause.
9. Noncompete provision.
For example, you and your business partner(s) may agree that if one of the partners leaves the business, they cannot open a competing business or work for a competing business within a certain number of miles and for a certain period of time.
10. Miscellaneous provisions.
Some examples include a provision for attorney’s fees for the non-breaching party if they win a lawsuit, a mediation or binding arbitration clause so you don’t have to go to court if you don’t want to, or a venue or choice of law provision on which state law would be applied in a contract dispute and where the dispute would be litigated.
Make sure you sit down with your partner(s) to discuss the best- and worst-case scenarios. Have a competent and honest attorney represent the company or have each partner hire an attorney to review the partnership documents and address the above issues, as well as the individual and specific needs of your and your partners’ particular situation.
The Best Entity for a Partnership
In most cases, the best structure for a partnership is the limited liability company (LLC). I realize there are unique situations where a corporation or a limited partnership might make sense; however, those are the exception and not the rule. In fact, if you need to save taxes, it’s typical to have each member’s share of the LLC owned by an S corporation.
There are three significant reasons why the LLC is such a perfect entity for partnerships. Here's a brief summary:
1. Its limited liability protection shields you from the acts of your partner (and vice versa). Without it, you have unlimited vicarious liability.
2. The operating agreement and corresponding initial minutes and formation documents are fantastic documents to define all of the partnership terms.
3. The flexibility of the LLC is beneficial for allocating profits, losses, and capital, as well as for allowing individual partners to do their own tax planning after they receive their allocated share of profit.
Information needed for creating a Partnership Agreement:
You'll need to have some information at the ready to create your Partnership Agreement, but most of it you probably know off hand. We'll guide you through the process with our step-by-step process so all you'll have to do is answer a few simple questions. Here are some of the key provisions in a Partnership Agreement:
- Partnership name. This will be the legal name of your partnership.
- Business address. This is the physical address for the partnership. If there is none or only a post office box, then choose the address for one of the partners.
- Names of Partners.
- Effective date of agreement. This is the date that the partnership will begin. The date should be shortly after the Partnership Agreement is signed by all the partners.
- Primary purpose of partnership. For example, to purchase and lease out residential real estate.
- Voting requirements for partnership decisions. Generally, there are three options, including:
- all partners have equal voting rights regardless of ownership percentage (meaning each partner has one vote);
- all decisions require a majority vote with voting rights based on ownership percentage; or,
- all decisions require unanimous vote.
- Specify how costs will be shared among the partners. Typically this is according to ownership percentage. However, costs may also be assigned by percentages to each partner.
- Specify how profits will be shared among the partners. Typically this is according to ownership percentage. However, profits may also be assigned by percentages to each partner.
- Specify which partners will have authority to sign checks from the partnership account.
- For each partner, specify how much (in specific amount) partner will contribute to partnership.
- Specify deadline for partners to make contributions to partnership (specific date).
- Specify who will maintain accounting of profits made by partnership. Typically, this is an accountant or one of the partners. This may be an accounting firm or a person.
- Specify how often partnership finances will be audited. The choices include every six (6) months, once per year or upon majority vote of partners.
- Specify the type of contribution account the partnership will maintain. This is the contribution account that will be used for all monies the partners give to the partnership. Each partner may have their own individual contribution account. Or, the partnership may have one large contribution account.
- Specify type of accounting records partnership will maintain. This will be either cash basis or accrual basis.
- Specify the partnership's fiscal year-end. Will be last day of month chosen.
- If partner withdraws from partnership, specify number of days the partnership, as an entity, will have to buy the withdrawn shares.
- If partner withdraws from partnership and partnership chooses not to buy withdrawn shares, specify number of days partners will have to buy withdrawn shares. Please note, that if withdrawn shares are not purchased by the end of this period, the partnership will be dissolved.
- Specify type of vote required to dissolve partnership. This may be unanimous, by a majority, single partner vote or some other method.