Protecting Yourself Within Your Business— The Partnership Agreement

It has been said that a bad partnership can be worse than a bad marriage. Having been through a couple of divorces, one of which was exceptionally painful emotionally and financially, I can only imagine what would happen if I had a business partnership turn sour. Thankfully, I received some advice early on that I have used in setting up short term or long-term business partnerships. That advice was relatively simple—create a partnership agreement.

Many people believe that creating the organizational structure of the business is sufficient. That produces what are ordinarily called “Articles of Incorporation” or “Articles of Organization.” These articles actually create a relationship between your company and the public, but do not define the relationship between multiple owners in a business. The consequences of not placing defined parameters on the roles, actions and powers of the various owners can be dire, and lead to destroyed relationships, embezzlement, and court cases. On the other hand, if a partner in a business entity understands from the outset, what their job is, what they may and may not do within the entity, and that there will be drastic consequences for them personally that can include fines, court cases, and even imprisonment if they exceed these boundaries, they are much less likely to try to “get away with it.”

One of the reasons that people fail to take action on Partnership agreements is the fear of having to bring up subjects that are negative just at the time that you are forming this great new enterprise and are excited about it. I learned something a long time ago, and it has been a governing principle in my life. “Honest people have no trouble demonstrating their honesty in writing!” If having discussions about protecting yourself and each other brings up anger and trust issues, then this might be a good time to find out that you are dealing with people who are innately not that honest. I would rather find these things out at the beginning rather than going ahead with the partnership regardless of how good the other person’s skills are in other areas. And I personally also try to establish an arrangement that is temporary to start but could be turned into a longer-term partnership if the “trial period” turns out to be positive.

State governments do want to keep things in line, so in addition to laws that prevent major crimes such as embezzlement, each state has adopted some form of the Revised Uniform Partnership Act, but unfortunately, it results in more of a one size fits all default set of rules where the business is not operating under a Partnership Agreement. These rules may not fit with your business or needed protections, so it would be strongly encouraged that you work with professionals who are licensed in your state, and can work with drafting a protective agreement for your business. There are nine categories of protections that should be included:

  1. Name of the Business Partnership—This should reference the name of the business and/or entity for which the agreement is being created and is included in any organizational articles for said business.

  2. Individual Contributions to Partnership—These are ordinarily stated in the form of capital or other resources that each partner has contributed to starting the business partnership.

  3. Partners’ Authority, Responsibilities, Compensation, Decision Making, and Limitations—This basically clarifies what the partners do, how the business makes decisions, and defines limits on use of funds, check writing, and other individual authorities within the business.

  4. Penalties for Violation—Once procedures, authorities, and limitations have been set, it is critical to include some “teeth” in the agreement for each owner, for the benefit of other owners.

  5. Management—While similar to #3 above, assignments need to be made for individual owners to oversee certain operational activities, including accounting, management, HR, etc.

  6. Addition of Partners—Provisions need to be made for growth, including the addition of other partners in the business.

  7. Dissolution, Death, and Departure—If a partnership is dissolved, or a partner departs either voluntarily, or by death, decisions need to be made to secure the continuity of the business, including rights of survivorship for heirs, buyouts, division of assets, etc.

  8. Profit or Loss Allocation—Arrangements need to be made to allocate gains and profits, either back into the business, or as disbursements to partners, and if a loss is incurred, how the partners will allocate those costs.

  9. Resolving Disputes—When partnerships are healthy and strong, disputes are resolved through discussion, when they are not, outside legal assistance is needed, whether that be mediation or court.

The important principles in all agreement forms are clarity and enforceability. We reiterate that it is most critical to involve legal advisement that will assist in creating a usable document, and that meshes well with any articles of organization and the deepest desires of all involved partners to create a productive business and a positive relationship between partners. The spirit of the Partnership Agreement brings life into the business and a greater desire of the partners to work together in a truly synergistic arrangement that exceeds the individual abilities of each owner. This type of business is truly built to last.


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