Understanding a partnership agreement vs. operating agreement is important if you want to form a partnership. Limited liability companies, also commonly referred to as LLCs, implement an operating agreement to provide details on how a partnership will work. Without this document, companies doing business together will likely fail due to unmet goals and failed expectations between the parties.

The Importance of Creating a Partnership Agreement

A partnership operating as a non-LLC business is free to enter into a similar agreement called a partnership agreement. States do not require this in a business partnership relationship, but without a clearly defined partnership agreement, your business will fall under the standard rules of your particular state. A partnership agreement is always to the benefit of the business in that it allows the members/partners, not the state, to decide how the business will operate.

The terms LLC and partnership are used interchangeably. This is because most multimember LLC are taxed as partnerships, thus being referred to as an LLC or a partnership. Likewise, the terms members and partners are used interchangeably at times. This is because a multimember LLC has members and a partnership has partners.

Why Is a Clear Partnership Operating Agreement Important?

An operating agreement outlines:

  • Who owns the company
  • How many employees the company has
  • How operations are to be carried out
  • How disputes are to be handled

A clear partnership operating agreement is a cushion of protection against conflicts and misunderstandings. With no direction and defined methods of operation, disputes are almost inevitable. As previously mentioned, if there is no partnership agreement, then the state will virtually control how your business will operate and function.

How Are Operating and Partnership Agreements Different?

Like an LLC operating agreement, a partnership agreement is very flexible regarding how you and your partner want to operate your partnership. Profits and losses are specified, along with the duties and obligations of each partner.

The Uniform Partnership Act, known as the UPA, and/or The Revised Uniform Partnership Act, known as the Revised UPA, are the laws that rule partnerships in each state, with the exception of Louisiana.

These documents dictate what happens when partnerships have failed to implement a partnership agreement. They are the basic rules of operation for partnerships and can be used to effectively manage many parts of your business. The downside, however, is that they are designed as a one-size-fits-all solution and have the potential do more harm than good.

Why Are Partnership Agreements Unique?

Partnership agreements are unique; this is in part because of the flexibility to cater to the partners'/owners' wishes. There are basic elements and obligations to be addressed in all partnership agreements to ensure the success of a joint venture.

The partnership needs to be identified, so the first thing to do is agree what you will name it. This could be the last names of the owners, first names, initials, or a fabricated name. When choosing a made-up or fabricated name, it is your responsibility to check and make sure it isn't already being used.

Why Do Some Businesses Fail?

Many businesses with great potential have failed because of disagreements over contributions. This is a critical component to be discussed at the beginning of a partnership. The agreement should define who is going to invest in the business before it opens. In other words, who will pay for inventory, property, licensees, fees, and so forth should be addressed. Who will manage certain aspects when the partnership is up and running are other elements that should be clearly outlined in the partnership agreement.

The Importance of Pinpointing Financial Needs and Monetary Allocations

Most likely, you and your partner do not share the same financial needs. Determining how and when profits and losses will be distributed is an important area of the agreement that needs clarity and understanding.

How Can Disputes Be Settled?

It is important to discuss how disputes will be settled. For example, when no agreement can be reached and a decision has to be made, a unanimous vote of all partners would be executed. An agreement on the appropriate action to take beforehand provides guidance when conflicts arise. Partnerships can be very rewarding, especially when clear and agreed-upon purposes and objectives are put in place. Most importantly, be sure that the partnership is developed as the result of a shared vision and values.

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