Equity Partnership Agreement: Everything You Need to Know
An equity partnership agreement is a legal document stating the rights and obligations of the partners in an equity partnership.3 min read
2. Types of Partnership Agreements
3. Lockstep Partnership System
4. Eat-What-You-Kill Partnership System
5. Basics of the Written Equity Partnership Agreement
6. Joint and Several Liability
7. Equity Ownership
8. Sweat Equity
Updated July 6, 2020:
A partnership is a legal arrangement where two or more individuals agree to pool their financial and human resources for a business venture. Each partner is given a portion of the profits and losses of the business.
An equity partnership agreement is a legally binding agreement between the partners of a partnership that sets forth the rights and obligations of the partners and the proportion of their equity in the business. An equity partner owns part of the company and is entitled to a percentage of the partnership's profits. An equity partnership agreement should spell out the rights and obligations of all the partners in the partnership, including the equity partners.
Types of Partnership Agreements
Partnership agreements are of two types, including:
- General partnership: Here, each partner has personal and collective liability. In general partnerships, each partner is responsible for his liabilities and the liabilities of other partners in the business.
- Limited Liability Partnership: In this type of partnership, each partner's liability is restricted to the proportion of his or her investment in the company. Also, partners do not share the responsibilities of other partners.
A partnership agreement sets forth the status of the company as either a general or limited liability partnership.
Lockstep Partnership System
A lockstep partnership is a type of equity partnership where senior partners who have spent more years with the business receive a more substantial proportion of the business profits compared to new equity partners. However, the business community no longer favors the lockstep partnership system.
Critics of the system note that it discourages partners who are eager to earn more and lacks accountability. However, advocates of the system argue that it shields partners from loss of earnings and reduces internal competition.
Eat-What-You-Kill Partnership System
The Eat-What-You-Kill Partnership System is the second form of equity partnership. In this system, each partner gets a certain proportion of the company's profits, and individuals also receive compensation for their efforts towards running the business.
Supporters of the Eat-What-You-Kill Partnership System argue that it allows partners to have more control over their earnings and customers and enables them to have a clear understanding of what they must do to achieve their target income.
The downside of this system is that it can lead to a lack of management because it gives no recognition to non-billable time partners spend managing the partnership. Additionally, the system also discourages the training of new or junior employees.
Basics of the Written Equity Partnership Agreement
An equity partnership agreement should list the rights, responsibilities, and obligations of each partner. The contract should also address the proportion of the company's profits that each partner will receive. Partnership agreements should also allocate losses to future partners.
Furthermore, the partnership agreement should address how the business will make important decisions for running its operations. In addition to these, the partnership agreement should discuss how the dissolution of the company will be handled in the event of a partner's exit from the partnership or death.
Joint and Several Liability
Only the general partners of a limited partnership are personally liable for the debts and obligations of the company. If the company goes bankrupt, the general partner's assets can be used to settle the debts of the partnership. However, all partners in a general partnership have joint and several liability. If one of the partners is involved in a lawsuit, all the partners can be sued along with that partner.
The equity partnership agreement should state each partner's equity ownership in the business. The equity owned does not have to be equal to the investment of each partner because equity ownership can also be based on non-monetary contributions such as the connections partners bring to the company or real-life professional and managerial skills.
Sweat equity is an investment of work and effort in a business, enterprise, or project. It is one of the ways of adding equity to a business. Sweat equity can serve as equity for partners who have no money to invest in a partnership. A Sweat Equity Agreement has no monetary value on its own. However, it provides value-adding actions and effort to the business.
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