Why you need a partnership agreement

Top 5 Reasons to have a Partnership Agreement

In Business 101, Contracts 101 by Shannon Montgomery

I took a minor hiatus from blogging here for a while. I put up a YouTube video which you can check out here and I appeared on a friend’s two-part blog which you can check out here and here. But this week I am back with some more legal information for you and your business! So let’s jump right in.

Today’s topic was inspired by a recent event in one of my client’s businesses. Luckily this client is smart and has been working with me since the beginning of this entrepreneurial journey. So when things went south with two of the business partners I knew we would be ok. Why is that you ask? Because I drafted a (killer might I add) partnership agreement for the business and my client, and all partners reviewed and signed prior to really starting any work.

What is a partnership agreement?

It is an agreement between all of the owners of a company. If the company is an LLC we call the agreement an operating agreement. For corporations, it is typically called a shareholder agreement. If it is organized as a general partnership, then we call it a partnership agreement. For this article, the use of partnership agreement will refer to all of the above.

Don’t just ignore this document

You really should get this agreement in place prior to starting work so basically when the company is formed. This will help ensure you are all on the same page with how you want things done.

Why you need this in place

But what happens when you and a friend or a few friends are super motivated and happy to start your business journey together but you fail to write out and agree to a partnership agreement? Things can get ugly.

Partnership agreements are not necessarily required by law, when you set up your business entity within your state it is unlikely that you have to file one. Most states have default rules for handling issues within a company and if you don’t have a written agreement, the default rules will apply. Just because you and your best friend have high hopes for the business doesn’t mean you will always feel that way. In fact, for my client and the partners…their bliss lasted all of 6 months. A written partnership agreement will manage the expectations of the partners and give each person the confidence to keep working on growing the business.

There are many reasons to have a written agreement but I am going to get into the top reasons here today.

  1. Avoid those default rules.

I touched on this above, but you really don’t want to rely on your State default business entity rules. They don’t typically provide the business owners with as much control as they want, and there are certain things such as requiring officers that you may want to write out. Having an agreement allows you to change the rules and suit your specific business interests.

  1. Clearly delineate who will control the business.

Your agreement should go over the amount of control each partner has. It can be based on ownership percentage and capital contribution or it can be set up differently if you prefer. You also want to consider what happens if and when a partner wants to sell their share. Is that new person going to come in and have as much control as the original founders? Think about what would happen if a partner dies, if you don’t plan for this in the agreement, you could end up in business with a partners spouse…

  1. Agree on the important things in advance.

A good agreement will lay out the most important issues such as dispute resolution, voting, and even removal procedures for troublesome partners. Dispute resolution might be the most important one to think about before you start your business. Your agreement might require mediation, or may designate a certain arbitrator to handle issues. Without having these things in writing there is no way to force any one partner to actually resolve issues, and that is not good business.

  1. To protect business assets.

Partnership agreements will protect not only the monetary assets of the business by addressing what happens if a partner dies, is disabled, or goes bankrupt. But it will also protect the intellectual property assets of the business through confidentiality clauses, non-competes, and non-solicitation provisions.

  1. To remove a problem partner.

I know you likely had the best of intentions when you started your business, but the reality is over time business partners can grow apart in business ideology. Sometimes a partner takes action or fails to take action that is actually harmful to the company. For example, in my client’s case, one or more of the partners was not contributing the sweat equity they promised and these roles were falling onto my already overworked client. You might also see this when business isn’t going quite as well as the partners originally anticipated, and their ROI isn’t coming in as fast as they need. They may start slacking in their duties or worse decide to start working with a competing business. Yet, they still own a part of your business. Having a process for dealing with this written out before things get bad is key to protecting the business from bad partners, and maybe even from yourself.

As I said, there are 100 more reasons to have a written partnership agreement. These are just a few that were proven to be even more important to me in the last few weeks. And just because you are going into business alone doesn’t mean you shouldn’t have an operating agreement in place. What if you add a partner down the line? Or what if you die? The state needs to know how to handle your business and if it is written out-your business assets will stay protected.

Get with an attorney in your state to help you draft these agreements when you’re just starting out. I promise you will be better off! If you have more questions or are interested in working with me, shoot me an email to shannon@montgomerypllc.com.


Please note that this is not meant to be legal advice for you or your situation, this is merely some legal research and knowledge on the given topic.