Key Provisions in a Partnership Agreement to Avoid Common Pitfalls
A partnership can be an ideal way to grow your business. It will offer extra financial stability and manpower while spreading out risk while still allowing you to maintain a level of control that isn’t possible if you choose to incorporate instead.
A key element of building a partnership is creating a partnership agreement. It should spell out the partners’ roles and responsibilities, financial benefits, dispute resolution, and an eventual method for exiting the partnership.
That being said, as you create your partnership agreement, you must be wary and work to avoid the following pitfalls:
Unclear Roles and Responsibilities
If your partnership agreement doesn’t delineate the roles of each partner, it can lead to several types of conflict. Your partner may decide that you wouldn’t have approved, or you might purchase something your partner has already purchased, wasting money in the process.
The partnership agreement should define each partner's duties, what sole decision-making authority each partner has, and when decisions must be discussed jointly or put to a vote. It should also detail time commitment and workload expectations.
Indefinite Profit and Loss Sharing
Another danger of a poorly written partnership agreement is the need for a definitive profit-sharing structure. If it isn’t clear how much money each partner should receive at some point, you or your partner will feel like you are being denied the money you deserve. Similarly, the agreement must be precise about how partners share losses. It isn’t fair if your partner receives a portion of your profits but loses nothing when you suffer a loss.
Nevertheless, profit and loss sharing should be set as distinct percentages based on each partner's contribution. Contributions will include factors such as capital investment, work performed, and experience in the field.
Finally, your agreement should account for unexpected situations. While you want precision, you will need a flexible option if things go sideways.
Inadequate Dispute Resolution Mechanisms
Disagreements between partners can set a business down the path toward extinction. And if these disputes become apparent to employees, customers, or other businesses you work with, it can also hurt your business's reputation.
As such, your agreement should include a straightforward process for addressing disagreements. It may give extra weight to certain partners based on their experience or roles. And when disagreements are severe, the agreement should require arbitration or mediation options before either party resorts to litigation. Still, regardless of how disagreements are resolved, all partners should agree to the dispute resolution process in advance.
Exit Strategy Ambiguity
Eventually, every partnership ends, whether because one partner wants to leave or someone dies. Therefore, your partnership agreement needs to be prepared for various contingencies involving a partner's exit.
Typically, you’ll want to define the precise ways one partner can buy out the ownership of another. For situations involving the death of a partner, it is usually essential that the option to buy the business belongs to the surviving partner, thereby preventing them from being stuck in a partnership with heirs who may not have the business's best interests at heart.
The agreement also needs to discuss business dissolution to prevent arguments about how to approach the end of a business if bad blood causes the need for it to dissolve.
Intellectual Property Rights
Finally, the partnership agreement should deal with intellectual property (IP) rights. Specifically, it should define what IP is owned by individuals and what is owned by the partnership. Once defined, the agreement should also establish usage rights.
The Importance of a Well-Drafted Partnership Agreement
A well-drafted partnership agreement can safeguard your and your partners' interests. It should prevent many disputes from arising and reduce the likelihood that any disputes that do occur result in litigation.
That said, when creating a partnership agreement, don’t try to create it alone. Consult with an experienced business disputes lawyer who can help ensure your agreement is legally sound and protects the interests of everyone involved.