The Importance of a Partnership Agreement
If you and your partners don't spell out your rights and responsibilities in a written partnership agreement, you'll be ill-equipped to settle conflicts when they arise, and minor misunderstandings may erupt into full-blown disputes.
How a partnership agreement helps your business
A partnership agreement allows you to structure your relationship with your partners in a way that suits your business. You and your partners can establish the shares of profits (or losses) each partner will take, the responsibilities of each partner, what will happen to the business if a partner leaves and other important guidelines.
Don't be tempted to leave the terms of your partnership up to local laws. Because they were designed as one-size-fits-all fallback rules, they may not be helpful in your particular situation. It's much better to put your agreement into a document that specifically sets out the points you and your partners have agreed on.
What to include in your partnership agreement
Here's a list of the major areas that most partnership agreements cover. You and your partners-to-be should consider these issues before you put the terms in writing:
• Name of the partnership. One of the first things you must do is agree on a name for your partnership. You can use your own last names, such as Smith & Wesson, or you can adopt and register a fictitious business name, such as Hammersmith and Kensington Home Repairs. If you choose a fictitious name, you must make sure that the name isn't already in use.
• Contributions to the partnership. It's critical that you and your partners work out and record who's going to contribute cash, property or services to the business before it opens - and what ownership percentage each partner will have. Disagreements over contributions have doomed many promising businesses.
• Allocation of profits, losses and draws. Will profits and losses be allocated in proportion to a partner's percentage interest in the business? And will each partner be entitled to a regular draw (a withdrawal of allocated profits from the business) or will all profits be distributed at the end of each year? You and your partners may have different ideas about how the money should be divided up and distributed, and each of you will have different financial needs, so this is an area to which you should pay particular attention.
•Partners' authority. Without an agreement to the contrary, any partner can bind the partnership without the consent of the other partners. If you want one or all of the partners to obtain the others' consent before binding the partnership, you must make this clear in your partnership agreement.
• Partnership decision-making. Although there's no magic formula or language for divvying up decisions among partners, you'll head off a lot of trouble if you try to work it out beforehand. You may, for example, want to require a unanimous vote of all the partners for every business decision. Or if that leaves you feeling fettered, you can require a unanimous vote for major decisions and allow individual partners to make minor decisions on their own. In that case, your partnership agreement will have to describe what constitutes a major or minor decision. You should carefully think through issues like these when setting up the decision-making process for your business.
• Management duties. You might not want to make ironclad rules about every management detail, but you'd be wise to work out some guidelines in advance. For example, who will keep the books? Who will deal with customers? Supervise employees? Negotiate with suppliers? Think through the management needs of your partnership and be sure you've got everything covered.
• Admitting new partners. Eventually, you may want to expand the business and bring in new partners. Agreeing on a procedure for admitting new partners will make your lives a lot easier when this issue comes up.
• Withdrawal or death of a partner. At least as important as the rules for admitting new partners to the business are the rules for handling the departure of an owner. You should set up a reasonable buyout scheme in your partnership agreement.
• Resolving disputes. If you and your partners become deadlocked on an issue, do you want to go straight to court? It might benefit everyone involved if your partnership agreement provides for alternative dispute resolution, such as mediation or arbitration.
As you can see, there are many issues to consider before you and your partners open for business -- and you shouldn't wait for a conflict to arise before hammering out some sound rules and procedures.