2. Profit and loss distribution.
Each partner's "distribution percentage" – reflecting their share of partnership profits and losses – must be clearly stated in the agreement. Partners share in the profits and losses to the extent of their share in the business. If each contributes 50 percent of the start-up money, then each is entitled to 50 percent of the profits, according to Weltman. Ennico adds, "distributions of profit must be made in accordance with the partners' percentages – if you don't do that, there's a risk that the partnership tax laws may rearrange your percentages to reflect how much money you and your partners are actually taking out of the partnership checking account.
3. Rules concerning voting, admitting new partners, and management.
Determine who is going to manage the partnership, who can sign contracts, and whether partners are going to be receiving salaries for labor or services. "Unlike distributions of profit, salaries do not have to be made proportionately to the partners," says Ennico. "I frequently see situations where unequal partners decide to take equal salaries for the work they're doing to further the partnership business." You also need to determine the voting rights of the partners -- normally a simple majority vote of the partners decides what happens and what doesn't, but you can agree that important decisions be made by a "supermajority" vote of two-thirds or more of the partnership percentages.. "For example, many partnership agreements require that the partners be unanimous when deciding to admit new partners, merge with another company, sell part of their business, or make a bankruptcy filing," says Ennico.
4. The exit strategy
The most important thing to spell out in a partnership agreement is your "exit strategy" if things don't go as planned and you want to get out of the partnership. "The dirty little secret is that as long as everybody gets along and everybody communicates and everybody does what they're supposed to, no one will look at the partnership agreement again," Ennico says. "The only time anyone is going to dust off the agreement and run to an attorney is when they are unhappy and want out."
This section details how to dissolve the partnership – the circumstances under which partners can withdraw, how much notice they must provide, and how the assets will be distributed. This section may also deal with other issues, such as what happens if one partner retires, goes bankrupt, becomes disabled, or dies. When such events occur, the departing partner's share of a business doesn't automatically get divided between the remaining partners. It is an asset that may be transferred by law to someone (such as a deceased partner's heirs, or to the partner's ex-spouse in a divorce proceeding) that you don't want to be partners with. If you don't want to be a partner with that "someone else", you may want to insist on a buy/sell clause that specifies that the surviving partners have the right to buy out that "someone else" in the event of a partner's death, disability, divorce, bankruptcy or retirement. If you do this, you should specify the method of determining the value of the departing partner's share.
Ennico says your partnership agreement should clearly state "who gets what" when the partnership dissolves, and spell out rules for what the partners can and cannot do afterwards:
"for example, can you still talk to your old customers? Can you take your customers with you? Are you prohibited from doing a similar business in the same geographic area as the partnership? All these things can and should be spelled out."
5. The means of dispute resolution.
In the event that partners have disagreements, you may want to include in your partnership agreement how those agreements will be worked out. You may want to specify that partners bring disputes to mediation before arbitration, go to arbitration directly, or agree to only go to arbitration.
Dig Deeper: Why Partnerships Fail
Structuring a Business Partnership: Recommended Resources
- Business.gov: Link to your location to find applicable requirements.
- Cliff Ennico, the small business attorney quoted in this article, has an excellent outline on the advantages and disadvantages of forming partnerships, LLCs and corporations, entitled "Demystifying the Business Organization," which is available without charge on his website.
- Internal Revenue Service: View IRS Publication 541, Partnerships, for guidance on partnership taxation.
- U.S., Small Business Administration: How to choose a business structure.
