You should not enter into a partnership agreement with someone based on a handshake. No matter how much you may trust that person, any business arrangements you agree to enter into need to be memorialized in writing. In a partnership, the agreement between you and your partner(s) is what gives you rights and obligations with respect to the partnership. If you are involved in any type of dispute, the partnership agreement will be the first place a court will go to decide the case.
You should strongly consider hiring a business lawyer to help you draft or negotiate a partnership agreement. There will be some things you overlook if you take matters into your own hands. If you do not have a lawyer, you may not realize that the partnership agreement is incomplete until you are involved in a dispute and there is no language in it to protect you. If you hire a lawyer, they can help you plan for problems and contingencies by suggesting language for the agreement that covers them.
Here are some of the things that should be included in a partnership agreement.
Decision-Making and Partners’ Authority
Overall, the partnership agreement should lay out procedures for your business that could reduce the potential for conflict. One of the most important contributions a partnership agreement can make is a clear discussion of how the partners will make decisions. The partners do not necessarily have to make each and every single decision jointly. The agreement could lay out the aspects of the business that each partner is responsible for making final decisions about.
However, each partner should have a role in major decisions. They should try to make them jointly, and the agreement should lay out a mechanism for making crucial decisions that affect the business. Partners are jointly and severally liable for the partnership’s debts, so their decisions should closely follow the process laid out in the agreement.
The partnership agreement should also detail the roles and responsibilities of each of the partners. There may be some things that are better suited to being handled primarily by one of the partners. For example, the partnership might benefit from one particular partner handling the technical aspects of the business while another handles the marketing. There should be clear discussion of the parameters of each partner’s role, and whether a partner has the final say regarding the area they are tasked with overseeing.
The partners’ roles and individual decision-making authority are a critical thing to address in the partnership agreement. Without limitations on a partner’s decision-making authority, they will have the ability to bind the entire partnership to any agreement they want. Thus, you may end up liable for a decision that another partner makes, even if you did not agree with it. Therefore, you may want to clearly define roles and authority so you do not end up paying the price for what someone else did without your consent.
Division of Profits
Business partners hope and intend for their partnership to make money. After all, that is the reason why you go into business. Not every partnership will divide the profits equally among partners. In addition, partners may not be able to take their money out of the partnership as soon as they earn it.
A partnership agreement will detail how profits are to be divided among the partners and how and when partners can take out profits. Otherwise, there could be frequent disputes over money because partners may want to take out money at an impractical time for the partnership.
The Partners’ Financial Contribution to the Partnership
Each partner may be called upon to contribute capital to the partnership. Any partnership needs to have sufficient capital reserves in case it encounters rough patches financially or in the event the business expands. A partner’s contribution can be held in their account as long as they are still part of the partnership.
The partnership agreement should detail when a partner may need to contribute capital and how much they need to give, including when a partner may be required to contribute additional capital if the business expands or runs into issues. The agreement should lay out the times when these additional contributions are required, as well as when and how partners’ capital contributions may be returned to them.
Adding or Subtracting Partners
Your partnership may grow over time. If your business expands, you may also need to expand the number of partners so the business can earn additional revenue. Your agreement should have a formal procedure for adding new partners to the business, such as a voting mechanism where partners would decide whether to admit a new partner. When adding voting mechanisms, you can require a majority vote or a unanimous vote in order to move forward with the decision.
The same thing goes for removing partners from a partnership. It may be necessary to terminate or expel a partner. You need a set process, both to protect you and to allow you to remove other partners who may not be performing or who are not contributing constructively to the partnership.
A Disputes Clause
A disputes clause is one of the most important clauses in a partnership agreement. Partners enter an agreement with the best of intentions. But when they do business together, they may come to see things differently over time.
Partnership disagreements can be laden with emotion. The disputes clause is a way to incorporate an objective, unbiased procedure for resolving disagreements. The language of your disputes clause should be customized to your specific business arrangement.
The purpose of a disputes clause is to keep a disagreement between the partners from destroying the partnership itself. The focus of most disputes clauses will be the procedure for resolving a dispute. A disputes clause may also give a timeframe for resolving a dispute to keep it from continuing indefinitely. If you and your partners still cannot work out the disagreement, there may even be a procedure in the clause to break the deadlock. For example, you and your partners may agree to bring in a third party to have a tie-breaking vote when you are deadlocked.
Depending on how you and your partners want to resolve disputes, you could insert language in the disputes clause that requires you to go to mediation to help you come to an agreement. Some partnership agreements even include a requirement to arbitrate the dispute to keep it out of court.
Other Provisions Regarding Deadlocks
There may still be times when you and your partners cannot work together. The question then becomes what happens to the partnership itself. Will the partnership be forced to dissolve because you and your partners cannot agree?
You may not want to let a disagreement mean the end of your partnership. You may have built up too much value in the partnership and put in quite a bit of work to let an argument mean the end of the business itself.
One common provision that you may want to consider including in a partnership agreement is a buy-sell provision. Most buy-sell provisions allow one or more partners to buy out other partners’ interests once the provision is triggered. The partnership agreement will lay out the triggering events. Most often these are deaths or retirements, but a buy-sell provision can also be used if there is an intractable disagreement. Usually, there is a method in the partnership agreement for valuing the business at that point, although the valuation is often subject to disagreement.
Every partnership should have some variation of this clause in its partnership agreement to prevent conflict from ending the entire partnership. You should have some way of purchasing the other partners’ interests that can allow the business to continue. Of course, the other partners may wish to exercise this clause themselves.
Dissolution
There are times when the partners could decide that they no longer want to work together. Alternatively, a lasting disagreement could force the end of the partnership. Ending the partnership is not as simple as saying that it is over. There is a process that must be followed before the business affairs of the partnership can be wound down for good.
The partnership agreement must specify what happens during this period. It is in your best interests to have an orderly dissolution of the partnership. Otherwise, you could end up involved in litigation regarding anything that happens between the beginning of the dissolution process and the end of the partnership.
Getting dissolution right is critical because each individual partner can be financially responsible for the actions of other partners. You do not want to be on the hook for something that another partner does during the time when your business is being wound down. Thus, there should be detailed procedures in the partnership agreement for what happens during the dissolution period. The dissolution clause could actually protect you if you are facing a lawsuit for what another partner did during the time the business was ending.
Your Partnership Agreement Should Include Some Flexibility
Your partnership agreement should not necessarily be a static snapshot of a single point in time. Conditions may change for your business as it grows. For example, you may add many new partners, or you may experience a sudden windfall. You may feel the need to amend your partnership agreement over time to reflect your new circumstances.
A partnership agreement should contain a provision that discusses how and when it could be modified. You and your partners may agree on future changes necessary to adapt your business and partnership to changing times.
Also, you need to pay close attention when the partnership agreement is being drafted and before it is signed. Once the agreement has been signed, it likely can only be changed with the consent of all the partners. Thus, you would not be able to make any amendments if you were already involved in a dispute or you realized a particular clause in the agreement treats you unfairly.
You Need an Attorney to Help Craft a Partnership Agreement
One key thing that you hopefully have learned by reading about each of the essential clauses in a partnership agreement is that you should not attempt to draft contracts. If you turn to an off-the-rack standardized legal form, you may end up in a world of trouble. “One-size-fits-all” DIY forms often cause legal hassles that cost you much more money than you would save by not hiring an experienced Houston contract drafting and review attorney to help you draft the agreement in the first place.
Your lawyer will sit down with you to learn more about your individual business before they put pen to paper. They will consider various contingencies and scenarios and will account for them in the language of the partnership agreement. Hiring an attorney to help you draft the partnership agreement is a worthwhile investment in your business.
Having a professionally drafted partnership agreement will help you if you encounter challenges in your business. The first thing that a court will look to is the exact language of the partnership agreement. It will be used to decide any legal disputes between the partners. If there are any ambiguities, they could lead to unpredictability and a result that you may not have intended.
At the same time, if you are involved in any dispute regarding the partnership agreement, you need an attorney at the outset of the disagreement. An experienced business lawyer will review the language of the agreement and advise you of your legal rights. They will then help you map out a plan for resolving the disagreement, negotiate a solution with the other partners, and/or take your case to court.
The business lawyers at Feldman & Feldman can work with you at all stages of the partnership process. We can draft a partnership agreement and/or assist you when you are involved in any disputes. You can contact us to speak with an attorney.