Key Takeaways

  • A partnership operating agreement establishes clear rules for ownership, management, profit sharing, and dispute resolution in a partnership.
  • Including clauses on buy-sell agreements, non-compete, and confidentiality can protect the partnership long-term.
  • It’s critical to address succession planning and dissolution scenarios to avoid automatic dissolution or legal challenges.
  • Different voting methods, profit allocation schemes, and partner roles should be explicitly defined to reduce conflicts.
  • Legal advice is recommended to ensure your partnership operating agreement aligns with state laws and partnership goals.

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

Benefits of a Partnership Operating Agreement

A well-drafted partnership operating agreement offers numerous benefits, including:

  • Legal Protection: It formalizes the business relationship and reduces the risk of misunderstandings.
  • Custom Rules: Partners can override default state laws that would otherwise apply in the absence of an agreement.
  • Clarified Responsibilities: Each partner’s roles and duties are clearly defined, helping to streamline management.
  • Dispute Minimization: Built-in processes for resolving disagreements can help avoid costly litigation.
  • Continuity Planning: It ensures the business continues smoothly in the event of a partner’s departure or death.

Without a partnership operating agreement, state default rules govern your business—which may not align with your preferences or needs.

Important Aspects of a Partnership Operating Agreement

Voting Powers

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.

Profit Allocation

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.

Management

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.

Ownership Interest

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.

Succession and Dissolution Planning

A strong partnership operating agreement addresses what happens if a partner retires, becomes incapacitated, or dies. Key considerations include:

  • Succession Rights: Define how a departing partner’s interest is transferred—whether to remaining partners, heirs, or external buyers.
  • Dissolution Triggers: Identify events that can lead to automatic dissolution and specify ways to avoid it (such as a buyout clause).
  • Asset Liquidation: Describe how assets and liabilities will be handled if the partnership dissolves.
  • Continuation Terms: Allow the business to continue with remaining partners instead of dissolving upon a partner’s departure.

Proactively planning for these scenarios protects the business from instability or forced closure.

Transitions

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

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

Legal Compliance and Updates

Your partnership operating agreement should be reviewed periodically to ensure it stays compliant with evolving laws and business changes. Consider:

  • Regular Reviews: Schedule periodic reviews, especially after major legal or business shifts.
  • Amendment Procedures: Clearly outline how the agreement can be amended, including voting thresholds required for approval.
  • Compliance Checks: Work with an attorney to ensure the agreement complies with applicable state and federal regulations.

Keeping the agreement updated safeguards the partnership’s legal standing and operational clarity.

Additional Clauses to Consider

In addition to the core elements, you may want to include these clauses in your partnership operating agreement:

  • Buy-Sell Agreement: Specifies how a partner’s ownership interest can be sold or transferred, including pricing mechanisms.
  • Non-Compete Clause: Prevents partners from operating competing businesses during or after leaving the partnership.
  • Confidentiality Clause: Requires partners to maintain the confidentiality of sensitive business information.
  • Intellectual Property Ownership: Clarifies ownership of IP developed by partners during the partnership.
  • Withdrawal Procedures: Outlines the process for a partner to voluntarily exit the business.

Including these provisions provides additional legal and operational safeguards tailored to your partnership’s needs.

Frequently Asked Questions

  1. Is a partnership operating agreement legally required?
    No, it’s not legally required in most states, but it’s highly recommended to avoid disputes and default state rules.
  2. Can a partnership operating agreement be changed later?
    Yes, but the agreement should specify how amendments can be made—usually by a majority or unanimous partner vote.
  3. What happens if we don’t have a partnership operating agreement?
    Without an agreement, state default laws govern issues like profit sharing and dissolution, which may not reflect your wishes.
  4. Do I need a lawyer to draft a partnership operating agreement?
    While not mandatory, legal guidance ensures the agreement is enforceable and tailored to your partnership’s needs.
  5. Can a partnership operating agreement cover non-business matters?
    Generally no—it focuses on business operations, but related issues like confidentiality and intellectual property ownership can be included.

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