Have you ever thought about going into business with a good friend, or bringing on a business partner whose great ideas jive well with your own? While it may seem simple, joining forces with a like-minded entrepreneur to form a business partnership doesn’t come without risks.
To mitigate this risk while ensuring everyone involved in the partnership is on the same page and legally protected, you’ll need a business partnership agreement. Here’s what you need to know about these agreements, such as what they include and why they’re important.
What Is a Business Partnership Agreement?
A business partnership agreement — often called an Operating Agreement — is a contract between all parties involved in a joint business venture. It spells out the terms and conditions of the partnership, which can include:
- The official name, place and purpose of your business
- The percentage each partner owns in the company
- How much capital each partner is putting in
- Who makes the financial decisions and how final decisions are made
- How profits and losses will be distributed
- A detailed description of the management role and responsibilities of each partner
- How often official meetings to formally discuss the state of business will occur
- The length of the partnership
- Whether or how a partner can sell their share of the business (or purchase another)
- How and why the partnership may be dissolved
Besides covering all your bases, a business partnership agreement includes provisions that are specific to your business and the arrangement that you’ve all agreed on.
Why Is It Important to Have a Business Partnership Agreement?
While you may be excited to start a new venture with someone, it’s important to have everything in writing from the start so you can begin operations accordingly. Plus, you need to be prepared in case things go south and you need to dissolve the company. Even though you may have worked with your partner before or been friends for years, having a written contract that is a legally binding helps you achieve the following:
Define Ownership, Roles and Responsibilities
The business partnership agreement will indicate whether partners have equal ownership. If ownership is not divided 50/50, how will the company be legally split up? Putting this arrangement in writing is critical so all partners know their exact ownership interest from the start.
A partnership agreement will also clearly spell out which partner is in charge of what aspects of the business. Not only will it describe in detail the roles and responsibilities of each partner, but it will determine how decisions are ultimately made and who will have the final say (this will usually be informed by the ownership interest above).
Clarify Capital Contributions of Each Partner
How much money is each partner putting into your business? The last thing you want is to be surprised down the line when you’ve invested twice as much as your trusted partner!
If you need more funding, a partnership agreement should also state how you’ll go about seeking additional capital in the future. Having these things clearly outlined in your contract will avoid confusion and potential disputes.
This section of a partnership agreement should explain in detail when, how and how much money each partner can take out of the business. It also explains whether partners will get paid for reinvestments, and how any income from these investments will be divvied up among the owners.
Avoid Tax and Liability Issues
Having a written partnership agreement in place can also help avoid some tricky tax and liability issues. You’ll want to make sure you and your partners are following best practices for accounting and taxes. This can include having all partners separate their business and personal spending, and using a tool like Quickbooks to categorize expenses in preparation for tax time. A business partnership agreement will help suss out any liability issues that arise, and it can help protect each partner’s assets in case of financial troubles.
Deal With Changes and Problems
How will you proceed if changes become necessary in managing your business, implementing operational practices, altering procedures or modifying the ownership structure? Having a partnership agreement in place means you’ll be prepared to deal with any of these circumstances and more.
In the case of a partner’s death or disability, you need a written plan for who will take over, how decisions will be made and how shares will be divided. A business partnership can help figure out how to resolve any potential complications long before they occur.
What Types of Business Partnerships Are There?
Depending on what you intend for your company, there are several different kinds of business partnerships you can choose from. These business structures differ in the way that the liability is handled, and include: .
In a General Partnership, all owners have unlimited liability. This means that the personal and business assets of both individuals are liable for the firm’s debt. Additionally, if one of the partners commits an illegal act or is engaged in misconduct, the other partner can be held responsible…even if they are not directly involved in the offense.
Limited Partnership (LP)
A Limited Partnership offers limited personal liability for business debts. In such an arrangement, at least one of the owners is considered a general partner who makes the business decisions. This owner is personally liable for debts incurred by the business.
Limited Partnerships also have at least one limited partner. This partner may have invested capital to get the business running, but they may have a more limited role in how the business operates.
Limited Liability Partnership (LLP)
A Limited Liability Partnership has a similar business structure to a Limited Partnership. The major difference is it there are no general partners; every partner is a limited partner. All partners in an LLP own and manage a business. This means that for all owners, their liability for business debts is limited to the amount of their initial investment. Whereas partners in an LLP are responsible for the debts of the business, they may be exempt from the liability of their partners’ actions.
Limited Liability Limited Partnership (LLLP)
In a Limited Liability Limited Partnership, there are both general and limited partners, and they all have some form of liability protection. Normally, though, the limited partners will still not have much say in daily operations of the business.
As far as business structures for partnerships go, LLLPs are fairly new to the scene. In fact, they are currently only recognized in just over half of states. States that recognize the LLLP structure include:
- North Carolina
- North Dakota
- South Dakota
Limited Liability Corporation (LLC)
If you have business partners, you can draft up a partnership agreement for an LLC to protect the personal assets of everyone involved. Each partner in an LLC is called a “member.” With an LLC, the Operating Agreement is a contract among the LLC’s members that stipulates the LLC’s membership, management, operation and distribution of the company’s income. It also documents the roles, responsibilities, rights, and relationships of the members, as well as their respective ownership percentages and shares of profits and losses.
You can think of an LLC as a business structure that’s a hybrid between a corporation and a sole proprietorship: it combines the pass-through taxation of a partnership with the limited liability of a corporation. It’s a popular structure because its simpler and more flexible than a corporation. Whereas LLPs and LLCs share the same tax advantages, in an LLC a corporation can be a partner, whereas in an LLP a corporation cannot be a partner.
As you can see, there are plenty of reasons that having a partnership agreement is crucial when starting a business with a colleague. It not only helps define your business, but it helps you come up with an action plan in case of changes or unexpected events. If you have specific questions about your business case, you should seek the professional advice of a legal expert.
If you’re ready to create a business partnership agreement or need to learn more, let the Incfile team help. We have tons of resources that can help you start your business today. Over 150,000 businesses have already trusted us to guide them through the process and answer any questions they have along the way.
Latest posts by Jackie Lam (see all)
- Important: S Corporation Filing Deadline and Extentions - March 8, 2019
- Tips to Balancing Your Personal vs. Business Finances - March 8, 2019
- How to Set Your New Business Up for Tax Success - March 8, 2019