The simplicity of partnerships is alluring. They are easy to form, and often easy to operate. It can be tempting to hit the ground running with a partnership without first setting a partnership agreement out in writing. In this blog, I explore why a written partnership agreement is nevertheless important, and I review a few relevant terms to include in such an agreement.
Why do you need a partnership agreement?
A partnership agreement is not usually required by law, but there are nevertheless compelling reasons to draft one.
First, there is a set of default rules that will apply to your partnership in the absence of a written agreement, but those default rules won’t necessarily work well for your unique partnership. For example, the default rule that partners share profits 50/50 may not be desirable for a partnership where one or more partners contributes much more to the business than the remaining partners do.
Second, banks and lenders may require a written partnership agreement before they do business with a partnership. A written agreement signals to the business world that a partnership can be trusted with a loan or a business account.
Finally, a written agreement can help avoid disputes between the partners. Handshake agreements are a landmine for future litigation, whereas setting out the terms in writing ahead of time ensures that all partners are on the same page with respect to the partnership’s ownership percentages, assets, profit sharing, etc.
What should your partnership agreement include?
A well-drafted partnership agreement should, at a minimum, specify the following:
- The full legal names and addresses of all partners;
- The name of the partnership;
- The principal place of business of the partnership;
- The initial contributions each partner has made to the partnership;
- The inventory of assets owned by the partnership;
- The percentage of profits and losses assigned to each partner; and
- Whether the partnership is a general or limited partnership.
The above terms relate to the bare-bones structure of the partnership; however, it may be helpful for your partnership agreement to address some of these additional issues:
- Subsequent capital contributions. Whether partners will owe future capital contributions; and if so, when.
- Duties of the Partners. Whether specific partners will have specific roles with respect to the partnership.
- Management and Voting Requirements. How decisions relating to the operation of the partnership will be made, and what kind of voting majority is required for decision-making.
- Salaries and Benefits of the Partners. Whether the partners may receive any salary or benefits.
- Restrictions on Partners. Whether there are certain activities the partners may not engage in, such as partaking in other businesses that compete with the business of the partnership.
- Transfer of Partnership Interest. Whether a partner may transfer his or her partnership interest to a third party and, if so, the effect of such a transfer.
- Retirement, Withdrawal, or Expulsion of Partners. The terms and conditions for the voluntary or involuntary exit of a partner from the partnership.
- Dissolution of the Partnership. The events that trigger a dissolution of the partnership, and the procedure for such dissolution.
Note that while your partnership agreement can be tailored with respect to the above issues, sometimes there are non-waivable default rules governing partnerships. For example, in Illinois, a partnership agreement cannot contract away the partners’ respective rights of access to the partnership’s books and records, the various fiduciary duties owed by the partners, and the partners’ right to dissociate with the partnership. Accordingly, while drafting a partnership agreement can be fairly straightforward, it may nevertheless be helpful to consult an attorney to ensure you are on the right track.
If you are looking for assistance with forming a partnership or drafting a partnership agreement, contact our law office and schedule a consultation.