ABC’s of Partnership Agreements
When starting any new business venture or establishing a new business entity, having appropriate documentation is important. The importance of having such documentation is increased substantially when more than one person is involved. We often help clients by drafting their corporate bylaws or LLC operating agreements, both of which set out how the organization will operate as well as the rights and duties of the shareholders or members. However, many business partnerships are formed less formally and without the assistance of legal counsel. Even in those situations, it is imperative that the parties adopt a written agreement to govern their relationship. Not only is a written agreement vital in the event of a dispute, it provides guidance and clarity to the partners throughout the life of the partnership.
The agreement should be tailored to the particular partnership, type of business and goals of the partners, and neither partner should enter into the agreement without a complete understanding of its terms. The partners should rely on legal and tax counsel in drafting the agreement in a way that addresses their key concerns, is desirable from a tax perspective and protects their personal assets and interests.
There are certain provisions that should be included in even the most basic partnership agreement. An effective partnership agreement should, at a minimum, address the following issues and topics: ownership, voting, responsibilities and obligations of the partners, how assets and revenues will be distributed, how expenses and losses will be allocated, transfers of ownership interests, and dissolution of the partnership.
The agreement should set forth the identity of the partners, their respective ownership percentages, type of ownership (if there is more than one level or type of ownership), and their capital contribution.
The agreement should include information concerning voting rights, procedures, and what to do in the event of a deadlock.
Responsibilities and Duties of Partners
The agreement should state whether the partners have an exclusive duty to the company and define partners’ responsibilities and obligations with respect to the company.
Distribution of Assets/Revenues and Allocation of Expenses/Losses
The agreement should be clear with regard to how and when assets and revenues are distributed to partners and how expenses and losses will be allocated. This should be done with the tax implications in mind.
Transfers of Ownership Interests
The agreement should set forth any transfer restrictions, how, when and to whom ownership can be transferred, what happens to the interest upon death, disability or incapacity of a partner and how the interests will be valued in the event of a transfer.
The agreement should provide a process for dissolution including, but not limited to, how assets are distributed and when dissolution can or must occur.
A partnership agreement is a useful tool in running a business with another individual. It is also helpful in the planning stage in determining whether the potential partners are compatible and have a similar vision for the business. Many disputes and problems can be avoided by proper business planning and adopting a partnership agreement is a vital part of that process.