Key Takeaways

  • A partnership agreement defines rights, duties, and expectations among partners and helps prevent conflicts.
  • It should cover basics such as business purpose, partner contributions, profit allocation, and decision-making.
  • Restrictive covenants like non-compete, non-solicit, and non-disclosure protect the partnership’s interests.
  • Buy-sell provisions provide clarity on what happens if a partner exits due to death, incapacity, or other reasons.
  • Partnership allocations outline profit/loss distribution, but agreements should also address dispute resolution, dissolution, and succession.
  • Clear clauses on duration, partner roles, and termination help strengthen long-term stability.

The term of partnership agreement is a legal document that governs a business run by two or more individuals. With this structure, each person contributes to finances and/or skills to the business and takes part in its profits and losses. Partners may or may not have an active role in running the business. With the written partnership agreement, the individuals involved agree to share skills, work, and money to establish a for-profit business and set out terms by which the business in question will operate.

Characteristics of a Partnership Agreement

If you don't have a partnership agreement in place, the business may be in jeopardy if a partner is no longer able to participate. This legally binding document should establish all terms and conditions that apply to the operation of a partnership. Although you may be tempted to rely on a handshake agreement, doing so means you may be out of luck if a crisis occurs, such as a partner leaving the business. A business attorney can help you draft a partnership agreement that considers all contingencies.

Duration and Termination of the Partnership

A critical feature of any partnership agreement is defining how long the partnership will last. The agreement can specify:

  • Fixed-term partnerships: These end after a defined number of years or upon completion of a specific project.
  • At-will partnerships: These continue until partners mutually agree to dissolve them.
  • Termination triggers: Events such as bankruptcy, death of a partner, or violation of obligations can automatically end the agreement.

Including termination procedures helps avoid uncertainty and ensures a smooth transition if the business ends.

Elements of a Partnership Agreement

Your partnership agreement should include:

  • The name and type of partnership.
  • The doing business as (DBA) name if applicable.
  • Whether the partnership is perpetual or for a specific term.
  • The purpose of the partnership including products and services to be offered.
  • The types of partners, such as general or limited.
  • The contributions of each partner, including property, service, cash, and deferred contributions.
  • Process of admitting new partners including required contribution.
  • Required future contributions and how they will impact shares.
  • Profit and loss distributions.
  • Profit retention for business needs.
  • Roles and responsibilities of managers, including work hours.
  • Voting and decision-making procedures.
  • Financial statements and bookkeeping provisions.
  • How and when meetings are held.
  • How records are maintained.
  • Time off for partners.
  • Conflict of interest policy.
  • Business asset ownership.
  • Transfers and sales of partnership interests.
  • Continuity of the business if a partner departs or dies.
  • Non-compete, non-disclosure, and non-solicitation clauses.
  • Dispute mediation and arbitration.
  • Severability.
  • Provisions for a failure to make an initial contribution.
  • Circumstances in which partners can take a draw from their profit share.
  • Process by which a partner can be removed from the business.
  • Dispute mediation and arbitration procedures.
  • How and when the partnership agreement may be amended.
  • The state laws by which the partnership will abide for circumstances not covered in the partnership agreement.

The agreement should be reviewed and updated periodically to make sure all eventualities are accounted for.

Partner Roles and Responsibilities

Beyond financial contributions, a partnership agreement should outline each partner’s role in daily operations. This section can specify:

  • Which partner is responsible for managing employees, handling clients, or overseeing finances.
  • Whether certain partners are silent investors versus active managers.
  • The process for resolving disputes when partners disagree on operational matters.

By spelling out responsibilities, the agreement helps prevent overlapping duties and minimizes conflict.

Restrictive Covenants

These clauses are designed to prevent certain actions by partners to serve the best interests of the business. The primary types of restrictive covenants are non-solicit, non-disclosure, and non-compete, and your partnership agreement should ideally include all three. With a non-compete agreement, a partner who leaves the business may not start or work for a competing business for a certain amount of time within specific geographic boundaries. Non-disclosure protects confidential information when a partner leaves the business; he or she may not disclose these details to third parties or use it to harm the partnership. Non-solicit agreements prevent a partner from stealing clients when he or she leaves.

Dispute Resolution and Mediation Clauses

Disputes are inevitable in long-term business relationships. A well-drafted partnership agreement should include mechanisms such as:

  • Mediation or arbitration before resorting to litigation.
  • Designation of a neutral third-party mediator or arbitration service.
  • Jurisdiction and governing law to apply in case of unresolved disputes.

These clauses provide an efficient way to resolve conflicts while protecting the business from costly lawsuits.

Buy-Sell Agreement

These provisions can be a separate agreement or be integrated as a clause in the partnership agreement. The buy-sell clause indicates how the partnership will proceed if a partner becomes incapacitated or dies, if the partnership dissolves, or if a divorce affects ownership. It can also provide guidelines to follow in the event of bankruptcy.

Having a solid buy-sell agreement prevents partners from making decisions in the heat of the moment when an unexpected situation occurs. You should include guidelines for establishing the business's value, how the purchase price must be paid, and whether insurance exists to make up part of the purchase price.

Dissolution and Succession Planning

In addition to buy-sell provisions, it is wise to plan for dissolution or succession. This includes:

  • Establishing how assets and debts will be divided if the partnership dissolves.
  • Creating a succession plan for transferring ownership if a partner retires or passes away.
  • Setting out procedures for admitting new partners to maintain business continuity.

Such planning ensures that the business remains stable during transitions

Partnership Allocations

This section indicates exactly how profits and losses should be divided among the partners. This is often done based on interest percentage and ownership, but another arrangement can be established in the partnership agreement. This also allows you to properly represent the business's finances with the IRS. The agreement should also address profit distributions and other forms of compensation.

Capital Accounts and Record-Keeping

Each partner typically maintains a capital account reflecting their initial and ongoing contributions. The agreement should specify:

  • How capital accounts are adjusted for profits, losses, and withdrawals.
  • Whether partners can take advances against future profits.
  • Requirements for financial reporting and record-keeping, such as annual audits or access to accounting records.

These provisions build transparency and protect all partners by keeping financial matters clear.

Frequently Asked Questions

  1. What is a partnership agreement?
    A partnership agreement is a legally binding contract that outlines how two or more people run a business together, covering roles, contributions, profits, and exit terms.
  2. Is a written partnership agreement required by law?
    In most states, it is not legally required, but without one, default state laws apply—which may not align with the partners’ intentions.
  3. How are profits typically divided in a partnership?
    Profits are usually split based on ownership interest, but the agreement can specify alternative arrangements.
  4. What happens if a partner wants to leave?
    A buy-sell clause or dissolution terms in the partnership agreement outline how their share is valued, transferred, or bought out.
  5. Can a partnership agreement be changed?
    Yes. Agreements should be reviewed periodically and updated with the consent of all partners to reflect business growth or changing needs.

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