- A business partnership agreement is a legally binding document that outlines business operations, ownership stakes, financials and decision-making details.
- When coupled with other legal entity documents, business partnership agreements could limit liability for each partner.
- Business partnership agreements should always be written or reviewed by legal counsel before they are signed.
- This article is for business partners who want to formalize their partnership with an airtight business partnership agreement.
A business partnership agreement is a document that establishes clear business operation rules and delineates each partner’s role. These agreements are enacted to resolve disputes, delineate responsibilities, and define how to allocate profits and losses.
Any business partnership in which two or more people own a stake in the company should have a business partnership agreement. This legal document provides critical guidance in a company’s operations.
We’ll explore what a business partnership should include, as well as share resources and best practices for creating this critical legal document.
What is a business partnership agreement?
A business partnership agreement is a legal document between two or more business partners that spells out the business’s legal structure and purpose. It outlines the following information:
- Individual partners’ responsibilities
- Capital contributions
- Partnership property
- Each partner’s ownership interest
- Decision-making conventions
The agreement also outlines what steps will be taken if one business partner decides to sell their interest or leave the company and how the remaining partner or partners would split profits and losses.
“I highly suggest formal partnership agreements are put in place as businesses evolve from solo practices into a partnership or ensembles,” said Rich Whitworth, former head of business consulting for Cetera Financial Group. “The biggest reason is that it establishes the ‘rules of engagement’ between the business and its owners … and lays out a road map on how to deal with entity-level issues.”
While businesses seldom begin with concerns about a future partnership dispute or how to dissolve the business, business partnership agreements are essential in situations in which emotions might otherwise take over. A written, legally binding agreement is an enforceable document instead of a spoken agreement between partners.
Did you know?: If you have an LLC, you’ll need articles of incorporation and an operating agreement to outline a business’s relationship with the state and the relationship between business owners.
How to write a business partnership agreement
A business partnership agreement must include all foreseeable issues regarding the business’s co-management. The easiest way to prepare a business partnership agreement is to hire an attorney or to find a customizable template. If you’re writing your own agreement, find a template for a company that’s similar to the business you’re starting.
A business partnership agreement should follow a logical process and include the following information:
- Business generalities. Start by stating the business’s name, its legal structure and the business’s location (i.e., which state’s laws will govern it).
- Business operations. State the partnership’s purpose, and explain the activities the business will and will not engage in.
- Ownership stake. Spell out the percentage of the business that each partner owns. Enumerate each partner’s rights and responsibilities.
- Decision-making process. Outline how decisions are made and the responsibility of each partner in the decision-making process. Include who has financial control of the company and who must approve the addition of new partners. Also include information on how profits and losses are distributed among the partners.
- Liability. If the business partnership is set up as an LLC, the agreement should limit the liability each partner faces in the event of a business lawsuit. To do so effectively, a partnership agreement should be paired with other documents, such as articles of incorporation. A business partnership agreement alone is likely not enough to fully protect the partners from liability.
- Dispute resolution. Any business partnership agreement should include a dispute-resolution process. Even if you’re working with family or best friends, disagreements are common in business.
- Business dissolution. If one or more partners choose to dissolve the business, a business partnership agreement should outline how that dissolution will occur. It should spell out the procedures for partners to join or leave the partnership. It should also outline continuity or succession planning for partners leaving the business.
- Explain how the partnership’s finances (including small business taxes) will be managed.
Once you’ve spelled out everything in detail, each partner must sign the agreement for it to take effect.
Tip: To ensure your business partnership agreement adequately covers all business liabilities, closely involve your legal counsel while developing and reviewing the agreement, even if you’re working from a template.
The stages of a business partnership agreement
A business partnership agreement doesn’t have to be set in stone, especially as a business grows and develops. You’ll be able to add to the agreement, especially if unforeseen circumstances occur. According to Whitworth, there are four primary stages to consider.
- Initial partnership: This stage involves creating the initial business partnership agreement as described above. You’ll draft an agreement that governs the business’s general operations, decision-making process, ownership stakes and management responsibilities.
- Addition of limited partners: As a business grows, it might have the opportunity to add new partners. According to Whitworth, the original partners might agree to a “small carve-out of minor equity ownership” for the new partner, as well as limited voting rights that give the new partner partial influence over business decisions.
- Addition of full partners: Sometimes you’ll want to promote a limited partner to a full business partnership. A business partnership agreement should include the requirements and process for elevating a limited partner to full partner status, complete with full voting rights and influence equal to that of the original partners.
- Continuity and succession: At some point, founders may retire or leave the company without wanting to dissolve it. If you didn’t include continuity and succession planning initially, it’s crucial to outline your plan. Describe how ownership stake and responsibilities will be distributed among the remaining partners after the departing partners take their leave.
“Partnership agreements need to be well crafted for myriad reasons,” said Laurie Tannous, owner of law firm Tannous & Associates Inc. “One main driver is that the desires and expectations of partners change and vary over time. A well-written partnership agreement can manage these expectations and give each partner a clear map or blueprint of what the future holds.”
Key takeaway: Succession planning is crucial to ensuring a business’s survival when a founder dies or an owner leaves the company.
Free business partnership agreement templates
Business partnership agreement templates are available for free online. These resources can help you draft your agreement, but you should have legal counsel review your draft and help you revise and finalize the document before you sign it.
Once a lawyer confirms that your business partnership agreement is thorough and legally binding, you and your partners can sign it to make it official.
When you’re searching for business partnership agreement templates, start with the following resources:
Business partnership agreement mistakes to avoid
Partnership agreements are complex documents. Unfortunately, many people get bogged down in details and make crucial startup mistakes in their partnership agreement.
Here are some common mistakes to avoid:
- Skipping key details. Partnership agreements typically include some complex language around specific topics, and people may leave out this language if they don’t understand it. Don’t assume something isn’t necessary just because it reads like fine print.
- Trusting things will work out. People tend to go into business with people they like and trust, leading them to think there won’t be problems later. A partnership agreement exists to resolve these issues when they inevitably arise.
- Not having the agreement reviewed by counsel. Partnership agreements can vary by state and industry, and laws and best practices are constantly changing. If you choose not to have an attorney draft your agreement, at least have one review it before you sign the document.
- Not amending the agreement later. Partnerships evolve, and governing documents must be updated periodically to reflect the changing business. Otherwise, there may be issues that the document can’t resolve.
- Not forming separate partnerships for new ventures. Creating a business is expensive and time-intensive. Sometimes when a partner has an idea for a new business, their first thought is to make it part of their existing partnership. However, this keeps partners from compartmentalizing their liability. Often, their existing partnership agreement isn’t structured to govern new and different businesses.
Business partnership agreements formalize the relationship between partners and enumerate their rights and responsibilities. This limits partner liability and helps resolve disputes. Failing to draft an appropriate agreement can lead to problems later, including significant personal liability.
Why do you need a business partnership agreement?
A business partnership agreement establishes a set of agreed-upon rules and processes that owners sign and acknowledge before problems occur. If any challenges or controversies arise, the business partnership agreement defines how to address them.
“A business partnership is just like a marriage: No one goes into it thinking that it’s going to fail, but if it does fail, it can be nasty,” said Jessica LeMauk, marketing director at Voxtur. “With the right agreements in place, which I’d always recommend be written by a qualified attorney, it makes any potential problems of the business partnership much more easily solved and/or legally enforceable.”
In other words, a business partnership agreement protects all partners if things go sour. By agreeing to a clear set of rules and principles at the partnership’s outset, partners exist on a level playing field developed by consensus and backed by law.
Business partnership agreements level the playing field
A well-crafted, airtight business partnership agreement clarifies each partner’s expectations, duties and obligations. In business, things change constantly, so it’s crucial to establish a business partnership agreement that can serve as a grounding force in turbulent or uncertain times. A business partnership agreement also defines how the business should grow and governs the addition of new partners.
If you’re going into business with a partner, establish a business partnership agreement while incorporating as an entity. Even if it seems unnecessary today, when an issue arises, you’ll be glad you had an agreement in place.
Dock Treece contributed to the writing and reporting in this article. Source interviews were conducted for a previous version of this article.