A written partnership agreement is not required to form a Partnership, but it is vital to avoid uncertainty.
Even the best of friends or close family should create and sign a business partnership agreement to avoid misunderstandings and legal problems that can arise – even when there’s no disagreement. A partnership is a less-formal operating structure than an incorporation; a partnership agreement can protect owners in the event of the death of one partner, a dispute, a sale to a new partner or the dissolution of the business, among other benefits.
A partnership agreement spells out exactly who owns what percentage of a business. A majority partner may have more responsibility in exchange for more of the profits. Or they may request the opposite; taking a back seat and not interfering in operations, in exchange for putting up a bigger investment and taking a larger share of the profits. Most importantly, if the business is sold, a partnership agreement lays out who gets what.
When two 50/50 partners disagree, this can lead to problems when one partner makes decisions without consent of the other. Even when one partner is a majority owner, both partners can make decisions without approval of the other unless a partnership agreement limits one’s authority. An effective partnership agreement places limits on decisions either party can make, or awards control of the business to one of the partners.
For example, the agreement might state that neither partner can spend more than a set amount of business money, add or change products or services, relocate the business, sell to a new partner, hire or fire staff, or close the business, without the written approval of the other.
When one partner wants to end a partnership, it can cause major problems for the other(s). A partnership agreement should state how the business can be dissolved or a partnership transferred.
Partners usually go into business because they trust each another and enjoy working together. You could add a clause stating one partner cannot sell their share to a third party without offering the original remaining partner(s) an opportunity to buy out the other. Or, partners may need approval before they can sell to a particular party.
Some partnership agreements protect partners in the event of the death of one partner. The agreement may address the rights of heirs, i.e. allowing the remaining partners to buy the share of the deceased partner’s interest, rather than allowing a spouse or child to become a partner.
Partnership agreements can lay out who owns assets, such as the business name, customer list or recipes, if the business is dissolved.
Remember, under statutory law, if there is no formal partnership agreement to the contrary then profits and capital gains are automatically apportioned equally. This means that, for instance, if there are two partners they both receive 50%.