Partnership Operating Agreement: Everything You Need to Know
A partnership operating agreement is a document that outlines the roles, responsibilities, and rights of the owners and managers of a partnership.3 min read
A partnership operating agreement is a document that outlines the roles, responsibilities, and rights of the owners and managers of a partnership. It states the rules and regulations governing many aspects of the organization, ranging from voting powers to profit and loss distribution. While it is not a requirement for forming a partnership, it is an important document that can help prevent misunderstandings and disputes in the future.
What Is a Partnership?
There are three kinds of partnership: general partnership, limited partnership, and limited liability partnership. A general partnership refers to a for-profit business entity with two or more general partners. Each partner assumes equal liability for the obligations and debts of the business and one another's actions. A limited partnership, on the other hand, is a form of partnership that has a minimum of one general partner with unlimited liability and a limited partner with liability for his or her own portion of ownership only. In a limited liability partnership, each partner only assumes liability for his or her own actions.
What Is a Partnership Operating Agreement?
A partnership operating agreement refers to an internal document that governs a partnership. It specifies how money, disagreements, and rights of first refusal should be handled. If you are starting a business with someone else, there is a possibility that you and your partner will eventually part ways. The operating agreement will dictate how the breakup will occur. When you are drafting a partnership operating agreement, you need to include the following information:
- Name of your partnership
- Principal place of business
- Certificate of formation proving that you and your partners have indeed formed a partnership
- Name and address of the registered agent of your partnership
- Term of your partnership
- Voting rights of the partners
- Business purpose
- Addition of new partners
- Amount of initial contribution made by each partner
- Methods for maintaining records
- Handling of profits and losses
- Methods for distributing profits and losses
- Management fees
- Methods to be used by managers to run the partnership
- Powers of partners and managers
- Assignment of the rights of partners
- Continuance of the partnership if a member passes away
Important Aspects of a Partnership Operating Agreement
A partnership may be managed through majority voting by partners or by a managing partner. There are three ways to conduct voting, including:
- All partners have equal voting power, with each receiving one vote.
- Voting rights are assigned based on each partner's capital contribution.
- Voting rights are assigned based on profit distribution.
A partnership operating agreement will include information about the regularity of company distributions and the amount of money the partnership will retain. This will help partners prevent disputes with regard to how profits and losses should be distributed. Partners can choose to distribute profits and losses equally among partners or by fixed percentages.
A partnership's operating agreement will provide a description of its management structure. The company can appoint one or more partners or hire non-partners to manage its day-to-day operations. The roles of partners or managers in relation to the company's daily operations must be described in the operating agreement.
In addition, the operating agreement must contain information on each partner's contribution to the company. Usually, ownership interest in a partnership is determined by contributions of cash, property, and service.
The operating agreement of a partnership should also provide instructions for admitting new partners and dealing with a partner's departure from the company. In the event that a partner passes away or withdraws from the company, there is a chance that the partnership will be automatically dissolved. Dissolution can be prevented if the operating agreement specifies the procedure for purchasing a partner's ownership interest.
Disputes commonly occur in partnerships. However, contested issues can have a significant negative impact on your company's future. As such, it is important to include effective methods for resolving disputes in your partnership's operating agreement. Some methods of dispute resolution include:
- Allowing the CEO to have the final say
- Letting one partner have the final say on a certain aspect of the business
- Voting based on ownership
- Using a majority voting system
- Using an external mentor to resolve disputes
- Using an external advisory board
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