According to Noam Wasserman, author of The Founder’s Dilemmas, a whopping 65 % of new businesses fail due to conflict among co-founders. One way to avoid this fate is, of course, to choose the right business partner. Another way is to have a strong business partnership agreement, which is what this article covers.
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Why Should I Even Bother With a Business Partnership Agreement?
Running a business which has multiple owners without a business partnership agreement is kind of like driving a car without insurance. There’s nothing to protect you if something goes wrong. That gets at the main purpose that a business partnership agreement serves:
- Dispute resolution: Every relationship has disagreements, and this is especially true in business relationships where lots of financial, legal, and business decisions have to be made. A carefully crafted business partnership agreement allows you to outline how disputes are going to be handled ahead of time instead of in the heat of the moment. This prevents the friction and expenses associated with legal action.
A business partnership agreement can also do the following:
- Dispute prevention. By forcing you to have an honest conversation about how you want to run the business with your partner, disputes that may have otherwise occurred may not occur at all.
- Clarify business structure: The process of putting together a business partnership agreement forces everyone to think about and get on the same page about how the business is going to be structured and run from the beginning. This allows decisions to be made efficiently and profits to be divided fairly.
- Enable business transition: Should there come a time when one or more of the partners wants to exit the business, wants a partner to exit, passes away, or becomes disabled, there need to be provisions specifying what will happen to the business.
Keep in mind that there are different kinds of partnerships: general partnerships, limited partnerships, limited liability partnerships, and (in some states) limited liability limited partnerships. Learn more about how to choose a business structure in this guide. No matter which type of partnership you are creating, you should have a partnership agreement.
Business Partnership Agreement Free Template
Our trusted partner Rocket Lawyer has an excellent step-by-step template for creating a business partnership agreement. You will be asked a small series of questions to customize your agreement, and you can then download, print it, sign it, and share it with your partners for free. To go back and change the agreement later or to create multiple versions of the agreement, you have to upgrade to a paid subscription.
Should You Use a Lawyer or a Template to Create a Business Partnership Agreement?
If you can afford it, it is almost always a good idea to have an attorney involved with your business agreements. However, attorneys are expensive and likely do not have the same level of personal knowledge about your partners that you do. Because of this, if you do use a lawyer, it is always better to first have a good outline of what you and your partners want in the agreement.
There are several ways that you can get help from a lawyer. You can hire an attorney your own, but to save money, we recommend getting a lawyer through Avvo.
- Ask a general legal question and get answers for FREE! Avvo lets you post general legal questions for free, and attorneys will respond to you within 12 hours. Click here to try Avvo out.
- Ask a specific legal question and get answers for as little as $39. This is another service offered by Avvo. The catch is that you only get 15 minutes of a lawyer’s time and they will not review the actual documents.
- If you want a lawyer to help you create and review a partnership agreement, Avvo offers this service for a fixed price of $399. If you’re writing up the agreement yourself, and just want a lawyer to review it, that will be $199.
- For more complicated situations, you can use Avvo’s attorney network to hire a lawyer at an hourly or fixed rate.
What Should Be in a Business Partnership Agreement?
Business partnership agreements come in all shapes and sizes. What works for a two-owner retail shop in New York City may not work for a 4-owner law firm in Boulder, Colorado. Similarly, what works for partners who have worked together and known each other for years may not work for partners that just met. However, below are some of the elements that should generally be included in a good business partnership agreement.
Business Name and Purpose
- The name of the company, any other names that the company will be operating under, and the name of the parent company if there is one. If your company will use a fictitious business name (i.e. a trade name like “Sarah and Bob’s Bakery”), then that should be mentioned here.
- Statement of the company’s purpose. Generally you will want to keep this fairly broad so you have the flexibility to adapt and don’t have to revise the partnership agreement every time you try a new experiment or business venture.
Decide who is going to be responsible for which parts of the business. As discussed in our article on how to find the right business partner, at a minimum you need a partner involved with delivering your product and/or service, sales and marketing, finances, and management.
One partner may have multiple responsibilities, and sometimes, responsibilities may overlap in the day to day of the business. However, you should list out any other areas that need to be covered and decide who is going to be broadly responsible for those areas.
How will the workload be shared? Answer the following questions:
- Are partners expected to work set hours?
- Does one partner plan on working more or less than the other partners? If so, you may want to adjust division of ownership and profits accordingly (see compensation section below).
- How much vacation is allowed?
- Will this be a full time role for each partner or are partners allowed to conduct other types of businesses outside of the partnership? If partners are given more flexibility, there should be a provision specifying that other ventures cannot compete with the business.
Next, you want to determine what each partner is bringing to the business in terms of cash investment, physical property (equipment, office space etc), and intellectual/other types of property (software code, client lists etc.)
Once you have listed everything out, you should outline how that property will be owned and used. Here are some examples:
- Personal Property Example: You are starting a landscaping business and one of the partners contributes a lawnmower. Does that mower become the property of the business?
- Client List Example: You are starting brokerage firm and one of the partners brings clients with them from a previous job. Does 100 % of the revenue from those clients flow into the business?
- Intellectual Property Example: You and your partners launch an online business, and one partner contributes software code. Is that code now owned by the business? Can other partners modify it?
Now that you have decided on responsibilities, workload, and which partners are contributing what to the business, you can come to an agreement on how ownership is going to be shared in the business.
A 50/50 ownership, as Dan Shapiro explains further in this post, is not always the way to go. If a partner is doing any of the following, that typically merits their getting a larger ownership share in the business:
- One partner has contributed to a significantly larger amount of property to the business.
- The partner thought of the original business concept and/or developed a beta product, secured a patent, or completed another critical first step.
- Working full time while other partners are working part time.
- The partner has successfully raised venture capital funding.
Compensation/Distributions of Profits and Losses
Partners are not paid salaries. They receive distributions from the profits of the business. If there are no profits, says Michael Boutros, a lawyer and partner at Krevolin & Horst, LLC, then there are generally no distributions.
An exception to this is something called “guaranteed payments,” which is compensation that’s paid and guaranteed to a partner without regard to the profits and losses of a partnership. This is like a taking a salary. The IRS has certain rules and restrictions regarding the payment and treatment of guaranteed payments, say Boutros, so small business owners should consult with a lawyer and tax professional.
This section should answer the following questions:
- Do you plan on reinvesting profits back into the business?
- At what point do you plan on taking out profits and distributing them to the partners?
- How and when will profits and losses be divided up amongst the owners? Often, it’s based on contributions and ownership. For example, someone who contributes 60 % of the property to a business will typically own 60 % of the business and receive 60 % of the profits/losses. However, the setup may be different for your business if, for instance, one partner works a lot more than others or has more responsibilities.
- Will you offer guaranteed payments? If so, to whom, when, and how much?
Being able to discuss and come to an agreement on differences of opinion is a must for any business to move forward and grow. Most of the time, collaboration on day to day issues happens seamlessly. However, disputes are inevitable, and when the contested issues affect the future of the business, the agreement should lay out a method for resolution.
One common mistake small businesses make, says Boutros, is to give each owner an equal say in the business without including a tie breaker. Boutros explains, “When two 50-50 partners inevitably develop diverging views on a major company decision–whether to purchase a new building, or to invest in a new international division–the company reaches an impasse that impedes its long-term viability.” Here are some better ways to handle partner disputes:
- The CEO has the final say.
- One partner has the final say on a particular part of the business. For example, on hiring and firing disputes, it may be the CEO; for product development disputes, the partner who is in charge of product may have the final say.
- Vote based on ownership. For instance, someone owning 60 % of the business would have more of a say than someone owning 40 % of the business.
- Majority vote for businesses with an odd number of partners.
- Partners agree to use an outside mentor to resolve disputes.
- Partners agree to use an outside advisory board.
Other more formal options are:
- Mediation – Working with a professional mediator can help partners come to an agreement on issues that they were not able to resolve alone. For more on this option, see this article.
- Arbitration – If you are not able to come to an agreement through mediation then arbitration, which binds the partners to the decision made by the arbitrator, is the next option before going to court. For more on this option, see this article.
- Litigation – If things become too contentious and the business is not able to move forward, you can sue your business partner. This is usually a long and expensive process however, and one that will probably sour your relationship with the partner forever.
This section should answer the following questions:
- Contracts: Does each partner have the authority to sign contracts on behalf of the business? If so, those contracts will bind all partners.
- Debt: Is the business going to have a credit card, credit line, a loan? Keep in mind here that, depending on the business structure that you choose, each partner may be personally liable for this.
- Spending: Does a partner have the ability to make purchases without consulting the other partners? Generally, there is a limit that is set in the agreement above which point the partner must obtain permission from the other partners.
What happens if a partner dies or becomes unable to participate at the same level because of a disability? Most business owners probably do not want their deceased partner’s heirs to be their new business partners. To prevent these types of issues a buy sell agreement will be included in most business partnership agreements. A buy sell agreement allows remaining partners to buy out the partner who is disabled or who passed away. Buy sell agreements also usually cover partner divorces to prevent a divorcee’s ex-spouse from becoming a business partner. For a detailed overview of buy sell agreements see this article.
You should also look into key person insurance (aka key man insurance). This type of insurance enables the business to survive the loss of a key person. The insurance company will pay out a benefit to the business in case an owner or key executive passes away or becomes disabled.
Answer the following questions:
- Voluntary Exit: What happens if a partner wants to leave the partnership and pursue other interests? This is usually covered by a buy sell agreement.
- Involuntary Exit: Under what circumstances can a partner be forced to leave the business?
What is the process for deciding on bringing in a new partner? Majority vote? Some other method? Here is a great article on the topic from attorney Matt Dickstein.
Selling the Business
Under what circumstances can the business be sold? This likely goes back to the buy sell agreement.
Creating a business partnership agreement is a necessity for a small business with multiple owners. The agreement will cover the good times and bad times in your business. It covers how the business will be managed, how profits will be divided, and how disputes will be resolved. With a good partnership agreement under your belt, you can focus on running and growing your business!