Two heads are better than one, as the saying goes. And in no context is this truer than in business. Going into business with one or more partners has lots of benefits: pooled resources, diversity of ideas, and shared liability, to name a few. However, it’s important that partners are on the same page about key elements of the business, including respective responsibilities, areas of oversight, and each partner’s contribution. Having a well-constructed business partnership agreement between you will clarify and formalize answers to these critical issues.
What is a business partnership agreement?
A business partnership agreement is a legal contract governing an arrangement between two or more parties to operate a business together and share in the partnership’s business profits. A partnership entity subject to a business partnership agreement can take several forms, including the following:
General partnerships are the simplest form of partnership, in that two or more owners agree to combine forces to run a business and share in its profits (and losses). It functions like a multi-person sole proprietorship. The profits flow directly to the partners, who are taxed at their personal income rates. Also like sole proprietors, general partners share personal liability for the business’s debts or legal judgments.
A common structure in small businesses such as retailers, a limited partnership (LP) is an entity made up of at least one general partner and one or more limited partners. The difference from a general partnership is that, in a limited partnership, the limited partner is only liable for the business’s debts and legal judgments based on their ownership share (or a lesser or greater amount, if agreed to in a business partnership agreement).
Limited liability partnership (LLP)
LLPs are pass-through entities that enjoy the same tax benefits as general partnerships, along with a higher degree of liability protection for partners, who are not liable for debts or damages incurred by the business due to another partner’s conduct. In this way, the LLP is similar to a limited liability company (LLC).
Professional limited liability partnerships (PLLP)
PLLPs are essentially LLPs comprised of partners who bear some kind of professional license—such as an accounting firm, law firm, or health care provider, for example. These exist because it is illegal in some states for licensed professionals to operate LLPs. All partners in LLPs must provide proof of licensure to operate the business lawfully.
What is the purpose of having a business partnership agreement?
A business partnership agreement formalizes all the partnership affairs and terms of business operation. Having these partnership details written down in one place and explicitly signed off on by all partners is crucial for helping avoid disputes—or at least minimizing their impact on the business. Aside from laying out each partner’s role, other important reasons for having a business partnership agreement on file include:
A business partnership agreement establishes how much each partner has invested in the business and the amount each can expect to take in profit share.
A business partnership agreement outlines the percentages of partners’ authority, which usually translates to how much influence they have in making business decisions. For example, if one partner owns 65% of the partnership, that partner will likely have decision-making precedence over the other, who only owns 35%.
For limited partnerships, LLPs, and PLLPS, a business partnership agreement can designate the proportion of liability each partner shares in the business.
A business partnership agreement will contain instructions for other partners to follow in the event one or more partners decides to retire or dies while the business is still operating.
8 elements of a business partnership agreement
- Basic company information
- Investment plan
- Delegation of powers and partners’ participation
- Profit allocation
- Partnership property
- Dispute resolution process
- Protocols for termination
- Protocols for onboarding
No two partnerships—or business partnership agreements—are alike. Any partnership agreement should be tailored to fit the specific and unique needs of individual partnerships, as well as the individual partners within a partnership. Still, certain basic principals are present across companies and industries. Eight elements that all business partnerships agreements should contain are:
1. Basic company information
This includes the partnership’s name, location, names of individual partners, agreement effective date, and other basic information needed by tax authorities to officially recognize your business.
2. Investment plan
Investment details lay out the size of each partner’s capital contributions to the partnership funds, and how often these contributions will be made.
3. Delegation of powers and partners’ participation
This section typically outlines who makes decisions for the partnerships and how (for example, by vote according to partnership interest). It should also discuss which business partners handle specific areas of business operations, such as who will keep the books and who will be responsible for day-to-day operations.
4. Profit allocation
The part of the agreement on profit allocation addresses what share of the business profits each individual partner can expect to take home, and at what frequency. This usually reflects the percentage of the business each partner owns.
5. Partnership property
This includes what equipment, assets, or real property each partner is bringing to the business, and how that would adjust each partner’s interest.
6. Dispute resolution process
Because a business partnership agreement exists in large part to avoid or minimize conflicts, it ideally contains detailed language outlining how disputes between partners are handled. You might mandate that all partners first seek to resolve disputes through mediation, for example, before resorting to litigation. Or, it may define the governing law where any such litigation might take place (such as a specific state court where the business is headquartered).
7. Protocols for termination
Since some conflicts may be irreconcilable, business partnership agreements should outline procedures for terminating members who breach their duties. This section can also include procedures for how partners handle the death of another partner while the business is still in operation. For example, remaining partners may pay out the deceased partner’s interest to heirs, according to their ownership share in the business.
8. Protocols for onboarding
Your agreement indicates whether new partners will be allowed, and if so, how they will be brought onto the partnership.
How to create a business partnership agreement
There are three approaches you can take to create a business partnership agreement. They are:
- Collaborate with partners. Collaborate with partners to draft a business partnership.
- Assign independent tasks. Assign one or more partners to take on the task before allowing other partners to offer notes or propose amendments.
- Hire a lawyer. Engage a lawyer to write an initial draft, then allow legal representation for each prospective partner to review the terms individually.
Once all partners have come to a consensus on terms, each should sign and retain a copy of the entire agreement. All further amendments to the agreement after signature must be subsequently agreed to by all partners. Usually written consent is required.
Business partnership agreements FAQ
Can a business partnership agreement be customized to fit the specific needs of a business?
Yes. In fact, a business partnership agreement should be customized to fit the specific needs of a business. All partnerships are different. Some consist of only two equal partners; others contain many partners with various levels of ownership of the business. Although certain fundamental elements should be included in every business partnership agreement, the extent of (or inclusion of) certain terms will depend entirely on the specifics of the business.
Can I write my own business partnership agreement?
Yes, you can write your own business partnership agreement—but it’s important that all partners have the opportunity to read, assess, and offer any revisions to the partnership contract before signing. Given how complex contract negotiations can become, you may wish to consult the services of an attorney in drafting and/or negotiating and amending the agreement.
What happens if a business partner wants to leave the business before the end of the agreement?
Your business partnership agreement should lay out procedures for how to offboard a partner who wishes to leave the business, and outline contingencies for continuity and succession in the event a partner retires or dies. For example, you might agree to require a withdrawing partner to provide 90 days written notice before divesting from the partnership; or, you might agree to pay out the heirs of a deceased partner in accordance with their ownership interest.
Can you terminate a business partnership agreement?
Yes, you can terminate a business partnership agreement. You can outline a predetermined date for termination in the agreement itself, such as five years from the date of signature, which can always be extended by subsequent agreement of the partners. You can also outline causes for termination—such as the circumstances in which a partner’s breach of their fiduciary duties to the business could result in their removal from the partnership.
What makes a business partnership agreement legal?
A business partnership agreement functions like any other legal contract or formal agreement. Certain foundational elements of a contract law must be fulfilled for it to be enforceable. These include mutual assent among the partners, usually some kind of monetary investment, and a presumption that all partners were competent and of sufficient mind to sign a legally binding document.