Key Takeaways

  • A partnership agreement governs general partnerships and outlines partner roles, profit sharing, and dispute resolution.
  • An operating agreement governs LLCs, defining ownership, management structures, and liability protections.
  • Both documents help business owners avoid default state rules, which may not suit their needs.
  • Partnership agreements are highly flexible but carry unlimited liability for partners, while LLC operating agreements provide liability protection.
  • Clear financial allocations, dispute resolution methods, and exit strategies should be detailed in both agreements.
  • Choosing between a partnership agreement vs operating agreement depends on business structure, liability preferences, and long-term goals.

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.

Key Elements Found in Partnership Agreements

A strong partnership agreement typically covers:

  • Ownership percentages and contributions – what each partner invests (cash, property, or services).
  • Profit and loss distribution – how earnings and losses will be divided among partners.
  • Decision-making authority – whether decisions require majority approval, unanimous consent, or delegated authority.
  • Management roles – which partner oversees daily operations, finances, or strategic planning.
  • Exit and succession planning – what happens if a partner wants to leave, retire, or passes away.

By addressing these elements upfront, partners can reduce uncertainty and prevent conflicts later.

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.

Essential Provisions in an LLC Operating Agreement

An LLC operating agreement goes beyond defining ownership—it establishes a framework for governance and liability protection. Common provisions include:

  • Membership rights and responsibilities – voting rights, management duties, and member obligations.
  • Capital contributions – initial funding and any additional contributions required in the future.
  • Profit and distribution rules – timing and method of profit withdrawals or reinvestments.
  • Liability limits – ensuring members are protected from personal liability for company debts.
  • Dissolution procedures – what happens if the LLC closes or converts to another entity type.

Even in states where operating agreements aren’t legally required, having one creates clarity and ensures the LLC runs on its owners’ terms, not default state statutes.

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.

Choosing Between Partnership and Operating Agreements

The decision to use a partnership agreement or an operating agreement depends largely on your business structure and liability preferences:

  • If you want a simpler structure and are comfortable with unlimited liability, a partnership agreement may be sufficient.
  • If you want limited liability protection and more formal governance, an LLC with an operating agreement is a better choice.
  • Partnerships are often suited for professionals or small ventures, while LLCs appeal to startups, family businesses, and companies anticipating growth or outside investment.

Ultimately, both agreements safeguard owners from internal disputes and establish rules tailored to the business’s long-term needs.

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.

Common Mistakes to Avoid in Business Agreements

When drafting either agreement, avoid these pitfalls:

  • Relying on verbal agreements – informal arrangements rarely hold up in disputes.
  • Ignoring state default rules – these may impose unwanted outcomes if key issues aren’t addressed.
  • Failing to plan for growth – agreements should anticipate adding partners, members, or investors.
  • Overlooking buy-sell provisions – without them, ownership transfers can cause instability.

Proactively addressing these issues ensures the agreement evolves with the business and minimizes legal and financial risks.

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.

Tax Implications of Each Agreement

Understanding the tax treatment is essential when comparing a partnership agreement vs operating agreement:

  • Partnerships are pass-through entities, meaning profits are reported on each partner’s personal tax return.
  • LLCs also offer pass-through taxation by default but may elect to be taxed as an S Corp or C Corp, providing additional flexibility.
  • Self-employment taxes can differ depending on the chosen structure and whether members receive guaranteed payments or distributions.

Including tax provisions in the agreement helps avoid disputes and ensures compliance with IRS rules.

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.

Frequently Asked Questions

  1. Is an operating agreement required for an LLC?
    Not always. Some states don’t require it, but having one prevents conflicts and ensures members—not state law—control the business.
  2. Can a partnership operate without a written agreement?
    Yes, but it’s risky. Without one, state default rules will govern, which may not reflect the partners’ intentions.
  3. Which offers more liability protection: a partnership or LLC?
    An LLC with an operating agreement provides limited liability, while general partnerships expose partners to personal liability.
  4. Do both agreements affect how taxes are filed?
    Yes. Partnerships are taxed as pass-through entities, while LLCs have flexible tax options, including partnership, S Corp, or C Corp treatment.
  5. Can I convert a partnership agreement into an operating agreement?
    Yes. Many businesses start as partnerships and later convert to LLCs. A new operating agreement is then drafted to fit the LLC structure.

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