The purpose of partnership agreement (or partnership contract) is to establish a business enterprise through a legally binding contract between two or more individuals or other legal entities. This partnership agreement designates the rights and responsibilities of each partner or entity involved.

Types of Partnerships

There are a few different types of partnerships, the most common of which is a partnership between individuals. A partnership may also be made up of other types of legal entities, such as corporations or LLCs.

The partnership agreement includes the following elements:

  • Names and contact information of each individual partner
  • Purpose of the partnership and primary place of business
  • Designated terms of ownership
  • Amount of capital each partner invests in the business
  • Partnership shares
  • Directives about the distribution of profit among partners
  • Company management
  • Operation details

By establishing the partnership as a separate legal entity, individuals take advantage of the ability to separate personal assets from the business created. Partnership agreements require less complicated procedures than a corporation. A partnership is not required to file articles of incorporation with the government or keep corporate minutes.

Developing a partnership agreement with specific provisions allows the partners to develop and operate their business to their own objectives and desires, rather than being restricted by the law's default provisions, as governed by the state where the business operates.

It is not necessary or required to split up the company so that each partner owns an equal share. Through the partnership agreement, partners can choose to divide ownership interest in whatever way they see fit, so long as there is agreement among partners. It's also not necessary that all partners be actively involved in operating the business. A partnership agreement can designate a partner as an investor only.

Why Establish a Partnership?

Many individuals and even many businesses don't often make a partnership agreement before conducting business together, which can be a costly mistake. Many partners already have an existing, long-term relationship and don't foresee any issues arising in the future. Many family-owned small businesses simply don't recognize the necessity of a partnership agreement. However, families, as well as any other business or company partner relationships, are prone to disagreements, which may even result in legal action against one another.

A partnership agreement is designed to prevent internal legal problems and disagreements by clearly designating the roles of individual partners and the business operations. In addition, the establishment of a partnership is easy and offers each partner the advantages of working with larger amounts of capital, experience, and other resources. A partnership agreement is a document that can be used in addition to the state's legal forms required for establishing a partnership, although it is not required.

Information included in the partnership agreement can prepare each partner for anything that may occur, so long as the parameters defined are legal according to state statutes and federal laws. As an example, the partnership agreement cannot state that each partner is only liable for the business decisions he or she enacts individually. This is due to the Uniform Partnership Act, which states that each partner is liable for their own actions in addition to the actions of other partners and company employees.

In addition, partnership agreements can greatly impact the partnership's and individual partners' taxation. The amount of tax that each partner pays, along with the type of payment and capital distributions, are outlined in the partnership agreement. Although the IRS does not require a copy of the partnership agreement, if a partner or the partnership's taxes are audited, a copy will be necessary.

Potential Issues Arising From a Partnership

There are several common roadblocks that may arise and prevent you from working well with a potential partner. It's important to consider the likelihood of the following barriers:

  • Lack of inspiration or vision
  • Lack of defined purpose or lack of mutual understanding of purpose
  • Domination by one partner or competition between partners
  • Lack of commitment among all partners
  • Lack of communication
  • Lack of support from those with decision-making power
  • Philosophical differences
  • Lack of participation from key stakeholders
  • Insufficient understanding of roles and responsibilities
  • Overly burdensome financial and time commitments

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