We offer a rundown of what’s involved in setting up a business partnership agreement.
If you decide to partner with someone, it’s important to have this type of agreement in place. It should protect both your interests.
It’s also a good idea to have a legal professional review the agreement before you sign.
Pros and cons of business partnerships
Starting a business can be a very personal thing. Many entrepreneurs take on the bulk of the responsibilities for operating their businesses. Their businesses become “their babies”.
Sometimes, however, it makes sense to partner with someone.
Forming a business partnership can make business goals more achievable. At the same time, it exposes your business to new forms of risk.
Pros of a business partnership:
- simple to form, with few legal formalities
- limited external regulation
- access to additional knowledge and expertise
- someone to share wins and shoulder losses.
Cons of a business partnership:
- giving up some ownership, power and profit
- potential for conflict
- more complex decision-making
- can easily collapse.
What is a business partnership?
A partnership is any business entity in which two or more partners agree to share the profits or losses of the business.
Typically, each partner is expected to make a contribution in the form of capital, labour and/or expertise.
Each partner’s role and percentage interest in the business can be decided by the partners themselves.
In a registered company, just one of the partners may serve as the company’s director. Alternatively, the partners may share directorship.
Tips for a successful business partnership
Entering a partnership is not a decision to be taken lightly. A great business can be destroyed by a bad partnership.
Unlike other entities, partnerships have few hard-and-fast rules. The best way to avoid conflict is to follow strict processes from the start.
1. Write a formal partnership agreement
It’s not a legal requirement for partnership agreements to be in writing. However, a formal written agreement is important.
It should clarify each partner’s role and responsibilities, and specify the way forward in case of conflict or a partner deciding to leave.
2. Know your partner for a reasonable amount of time
Ideally, you should have a prior work relationship with someone before deciding to become business partners.
You need to know that this person is capable of doing the required job and that your personalities are compatible.
3. Start on the same page
To start a partnership on the right foot and avoid confusion and conflict later, open and honest discussions are essential. All partners should share the same core values and be aware of one another’s fears and goals for the business.
What to include in a business partnership agreement
Certain information should be included in a business partnership agreement.
Include the names and contact details for the partners, the name of the business partnership and its purpose.
State when the partnership commences and its duration – for example, until it’s cancelled per the terms in the agreement.
Also specify the principal location of the partnership (in other words, the principle business address).
Allocation of profits or losses
The agreement must specify each partner’s percentage interest in the business.
It should also clarify exactly how profits or losses will be allocated. Will this be in proportion to each partner’s percentage interest?
Also, when will each partner be entitled to withdraw their share of any profits? It’s vital to agree on when and how this will occur. It mustn’t compromise your business’s cash flow situation, or result in any partner being unfairly treated.
Finally, agree on a policy regarding loans. If a partner lends money to the business, how will the loan be repaid? Similarly, will partners be able to take loans from the business, and under what terms?
The agreement must specify each partner’s role and responsibilities. For example, will a partner be expected to contribute capital, assets, loans, investments or labour?
Will a partner work for the business full time or part time, and in what capacity?
Who is responsible for keeping the books and other management and administrative tasks?
Must any one partner get consent from other partners before acting on behalf of the business?
In the agreement, specify where business funds will be kept and what banking arrangements the partners will use to distribute profits or pay in funds to cover losses.
When setting up a business partnership agreement, specify where, when and how the business’s financials will be recorded.
For example, a simple agreement can just state that financial records will be maintained on a fiscal year basis, at the partnership’s principle location.
It may also stipulate that an audit of the partnership’s financial records be conducted annually by an independent party.
Guidelines for leaving
Clear guidelines for a partner leaving the partnership should be agreed.
For example, you might agree to liquidate the business and pay out any profits if this occurs. Alternatively, you can specify that remaining partners must be given the option of buying the interest of the partner who leaves.
The agreement should also list grounds on which a partner can be expelled from the partnership.
In addition, a partnership agreement should specify the following:
What must happen if one of the partners dies
It’s common to state that remaining partners must be given the option of buying that partner’s interest in the business.
How to determine the value of the business
Ideally, specify what methods should be used to determine the value of the business in the event of a sale, a dissolution or the death, disability or withdrawal of a partner.
What methods will be used to settle disputes
Deciding how to handle conflicts before they happen is a good idea. An example of a method you might specify is neutral arbitration.
Sample business partnership agreements
Note that ideally, the written agreement you use should be tailored to your particular partnership and business.
However, sample business partnership agreements can give you an idea what to include.
LegalWise offers a free South African partnership agreement template.
Another South African example is available here.
For reference, free templates for partnership agreements are also available from these overseas sites:
It’s best to have an attorney review the agreement you draw up before the partners sign.
What we offer at The Workspace
We do our best to provide useful resources to small businesses and entrepreneurs. However, please note that The Workspace does not offer expert advice on how to set up a business partnership agreement, or legal advice on any matter.