Starting a business partnership is exciting, but failing to create a comprehensive partnership agreement is one of the most common—and costly—mistakes business owners make. Without a written agreement, your partnership will be governed by your state's default partnership laws, which may allocate profits equally regardless of contributions, give every partner equal management authority, and create rules that don't fit your business.
The foundation of any partnership agreement is defining each partner's contributions. Document all contributions, whether cash, property, equipment, or services, and assign a value to each. This establishes the basis for ownership percentages and profit sharing. Be specific—vague contribution terms lead to disputes down the road.
Profit and loss allocation doesn't have to follow ownership percentages. Partners may agree to allocate profits differently based on involvement, skills, or other factors. For example, a partner who contributes capital but not labor might receive a different share than a partner who contributes primarily labor. Whatever arrangement you choose, document it clearly and consider the tax implications.
Management and decision-making structures must be defined. Will all partners have equal say in daily operations? Will certain decisions require unanimous consent? Consider creating tiers of decisions: routine business decisions that any partner can make, significant decisions requiring majority vote, and major decisions (like taking on debt or admitting new partners) requiring unanimous consent.
Address partner compensation beyond profit distributions. Partners may receive salaries, guaranteed payments, or other compensation for their work. These payments are typically made before profit distributions and should reflect the fair market value of each partner's services. Without clear compensation rules, disputes about who is contributing enough are inevitable.
Plan for partner exits from the beginning. Your agreement should cover voluntary withdrawal (with notice requirements and buyout terms), involuntary removal (grounds for expulsion and the process required), death or disability (what happens to a deceased partner's interest), and retirement provisions. Include a valuation method for determining the buyout price, such as book value, a formula, or independent appraisal.
Dispute resolution mechanisms are essential. Partners who are close friends or family often skip this section, assuming they'll always be able to work things out. This is a mistake. Include provisions for mediation as a first step, arbitration if mediation fails, and a process for handling deadlocks. These provisions save time, money, and relationships when disagreements arise.
Review your partnership agreement annually and update it when circumstances change—new partners joining, partners leaving, significant changes in contributions, or shifts in business direction. A partnership agreement is a living document that should evolve with your business. Consider working with an attorney to ensure your agreement complies with state law and adequately protects all partners.
