Partnership Agreement: What It Is
A partnership agreement is a contract between business partners that determines responsibilities, profits, and liabilities. This contract can be beneficial to any company if used correctly.
When running a business with other parties, it’s crucial to establish a written partnership agreement to reduce the potential for conflicts and complications down the line. The agreement is a protective measure used to ensure that disagreements are resolved quickly as each party is aware of their obligations, profit shares, and liabilities in the company.
What is a partnership agreement?
A partnership agreement is a type of business contract that states the specific obligations for the partners of a company. Usually, this agreement is formed before partners go into business with one another or directly after a company is created.
Its purpose is to determine how the business partners will manage responsibilities, ownership, profits and losses, investments, and company management. Although the word “partners” typically refers to two parties, a business partnership agreement has no limit on its number of partners.
Partnership contracts are commonly used for the following industries:
- Supply chain
Types of Partnerships
The type of agreement you and your partners use varies by industry, relationship strength, willingness to take on liability, investment strategy, and location.
There are four main types of partnership contracts:
- General partnership (GP): In a general partnership agreement, Owners share equal rights, responsibilities, and liability for all debts and obligations.
- Limited partnership (LP): Limited partners are only liable for up to the amount they invested, and the general partner has unlimited liability.
- Limited liability partnership (LLP): Each partner’s liabilities are equal to the amount they invested into the business.
- Professional limited liability partnership (PLLP): This is similar to an LLP except for licensed professionals.
Why your partnership needs a formal contract
Business partnerships are an essential step in the growth of your company. However, these partnerships should be governed by a written contract that you and the other parties agree upon. An agreement helps ensure that everyone’s on the same page and can help resolve any future disputes.
Additionally, each stakeholder can be sure that they are benefiting from what they put into the company.
Here are six of the ways that partnership contracts are beneficial:
Avoid the state’s default partnership rules
Even though you can have a valid partnership without a written contract, the business partnership will fall under the provisions of the state statutes. However, state laws can limit control and may cause distribution of profits, assets, debts, and liabilities inequitable to each partner’s contribution. A formal contract helps avoid potential inequity because it allows the partners to create terms that will serve in their best interest.
Reducing confusion once the business is running
Under general partnership provisions, each partner can make decisions regardless of whether or not the other partners approve of them. These decisions may put the entire business at risk. A formal agreement delineates all of the elements of the company and how each partner should manage them. It ensures that no one oversteps their boundaries and makes decisions without the consent of the other stakeholders.
Clearly establishes personal responsibilities for each partner
A business partnership agreement outlines each stakeholder’s level of authority, specific responsibilities, decision-making power, and management duties. It also determines how capital, profits, losses, and liabilities will be shared among the partners so that there aren’t disagreements down the line.
Forestall future arguments
Human memories tend to be faulty, and although it’s easy to just go by state laws or form a verbal agreement when using these methods, there are sure to be disagreements between the partners. Whether someone feels like they aren’t getting their fair share of profits or someone oversteps their boundaries, it’s best to have everything stated in a formal document that you can reference if a dispute arises.
Establish an exit plan
General partnership laws typically allow any partner to dissolve the partnership without prior notice or consent from the other stakeholders. Additionally, the association is automatically voided if any partners leave the business, become bankrupt, or pass away. A written contract determines the circumstances in which a partner can be expelled if they do not uphold the agreement’s end.
Avoid legal proceedings
Although you may incur legal fees when creating a written business partnership contract, this cost is much cheaper than the legal fees you will need to pay if litigation arises down the road.
A contract will help to avoid expensive legal proceedings by outlining alternate dispute resolution methods such as mediation, negotiation, or arbitration. Alternative dispute resolutions are beneficial because they allow the company partners to settle disagreements without spending time and money on traditional lawsuits.
Understanding the 10 elements of a partnership agreement
Every business venture is unique, but there are certain elements that each formal contract should include to avoid potential issues down the road. When you take the time to understand how each partner shares responsibility, finances, and other important aspects, you will limit confusion and disputes over who gets what or who’s liable for what.
There are 10 critical elements that each agreement between partners in business should include for it to be beneficial:
- The financial contribution of each partner
- The division of work between the partners
- What constitutes income and profits
- The property included in the partnership
- How individual partners will use the property
- How the partners will handle bank accounts, accounting, and tax matters
- Dispute resolutions in case of disagreements among the partners
- What will happen if one partner passes away or becomes incapacitated
- Leaving the partnership (buyout agreement)
- How to handle selling the business (exit strategy)
The key differences between partnership agreements and other contracts
A few other contract types are similar to partnership agreement contracts but have specific key differences. It’s important to understand these differences when creating a contract to enter the one that best suits your needs.
Here are the differences between a partnership agreement and other contracts:
The main difference here is that a partnership agreement is not registered in the court of law because it’s an agreement between the partners. A partnership deed is still an arrangement between partners but, it’s registered in the court of law.
Joint ventures are typically used for short-term partnerships, whereas partnership agreements can be indefinite. Separate entities often enter joint ventures for a single purpose, like accessing new markets or sharing costs.
Operating agreements are legally binding documents that LLCs utilize. So, you can have a partnership and operating agreement active at the same time. The purpose of an operating contract is to outline a company’s management, ownership, and structure.
How to write a partnership agreement using innovative contract tools
The best way to create, negotiate, manage, and sign a partnership agreement contract is by utilizing contract management software.
The software will automate the entire process from creation to closing, allowing you to spend less time and resources on the contract management process. And because the process is automated, you can use a pre-made partnership agreement format to ensure that you don’t leave out any necessary terms and provisions.