Partnership Agreement Fundamentals

The partnership agreement memorializes the understanding of the partners with respect to the major financial and operational aspects of the business, ensuring that all partners understand their roles and responsibilities in the partnership. A written partnership agreement establishes, in advance, what happens to the partnership if something happens to one or more of the partners—whether voluntarily (i.e. retirement) or involuntarily (i.e. death).

Basic provisions covered in the agreement include the name of the partnership and the name the partnership will operate its business under, the purpose for which the partnership will be formed, a description of the business the partnership will engage in, the length of the partnership, and how and when the agreement can be amended or changed. 

The agreement should also specify the type of partnership being formed—a general partnership, limited partnership or limited liability partnership. The type of partnership chosen can impact who makes day-to-day decisions, how profits and losses are distributed, and the legal and liability issues implicated in the partnership.

Some of the most important issues the partnership agreement should cover are issues related to finances. The agreement should outline the percentages of ownership and contribution of capital from each of the partners, both at the beginning of the partnership and in the future. It should outline how the partnership will distribute profits and losses, who can borrow money on behalf the partnership, who is required to authorize expenses, and who owns the assets of the partnership. It can also address how accounting books and records will be kept, and how and when financial statements will be presented to the partners.

Next, the agreement should address how the partnership will be managed and who has the power to make certain decisions. This can include who has management powers and duties, whether some partners will have limited or no power to make decisions, the skills each of the partner must contribute, and how and when partners are expected to work. It can also outline which issues and decisions require a vote of the partnership and how each partner’s vote will be allocated, as well as what percentage of votes is required to pass a vote. The agreement can also cover how often and where partnership meetings will be held and what constitutes a quorum for these meetings.

The five Ds – death, divorce, disability, dissolution, and dispute resolution--are among the most important reasons to reduce a partnership agreement to writing. The partnership agreement should be clear about what happens to the partnership in each of these situations. Failure to address these issues can have dire consequences. 

For example, if one of the partners dies, will their partnership share automatically pass to their children? Will a divorcing partner’s ex-spouse obtain an ownership interest in the partnership? The agreement should also consider what will happen if a partner becomes disabled or retires; how voting and decision-making, or existing contracts will be affected. Will the partner continue to receive profits and share in expenses? Can the partnership buy out the disabled or retiring partner, and if so, under what terms? Will retirement or death of a partner result in automatic dissolution, requiring that a new partnership be formed?

The agreement should also address how disputes are to be handled. Will arbitration or mediation be required before a lawsuit can be filed in court? Will partners be required to file a lawsuit in a specific state or jurisdiction?

The partnership agreement can also address issues such as whether partners are permitted to have outside businesses, and if so, under what conditions. Many partnership agreements include non-compete clauses, usually limited by both time and geographic area, preventing the partner from competing with the partnership’s business; non-disclosure clauses which prevent partners and former partners from revealing private business information and/or non-solicitation clauses, which prevent former partners from actively attempting to take employees or customers from the business. 

If you are considering forming a partnership, the partnership agreement is one of the first steps that needs to be taken, and in order to be addressed properly, a business or corporate lawyer should be consulted to ensure that the agreement is valid, contains all the necessary provisions, and is individually tailored to your business.