What Is a Partnership Agreement? (Components and Importance)
By Indeed Editorial Team
Published May 2, 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
A partnership is an arrangement where two or more parties oversee a business's operations and share its profits and liabilities. While partners can typically enter into a partnership through verbal agreement, a partnership contract helps record management accountability, ownership, and profit distribution. Learning about this document can help you understand its content better and perform activities adhered to the agreement at your workplace. In this article, we define a partnership agreement, review what to include in a partnership document, and discuss the types of partnerships.
What is a partnership agreement?
A partnership agreement or contract is a legal document that outlines a business's mode of operation and the relationship between the partners. This document shows the powers of each partner, clarifies ownership share and capital contribution, and explains profit distribution among partners. It may also include partnership duration, conflict and dispute resolution, and the introduction and exit of partners. This agreement can clarify who the owners of a business are and help resolve issues relating to debts and obligations.
There are numerous templates of a partnership document on the internet. Still, intending partners typically consult a lawyer to help interpret federal and provincial laws guiding a business' establishment and operations.
What to include in a partnership document
Below are the typical components of a standard partnership document:
Type of partnership
It's essential for a partnership contract to clarify the type of partnership due to their differences. The partnership type determines certain factors, such as the dissolution of the partnership and the distribution of profits and ownership. The three basic types of partnership are general partnership, limited partnership, and limited liability partnership.
Business name and address
Partners can agree on a name and ensure that it reflects in the document. This name can be the partners' last names or a fictitious business name. If a business eventually adopts a fictitious name, the owner may research adequately to ensure that no company is already using that name. The agreement can also contain the business address. If the owners have set up the business in multiple addresses, they may list out all while designating one as the headquarters.
Partnership purpose and start date
This section describes the reason or purpose for founding the company, and it's typically an overview of the company's primary products or services. A business's purpose is a general statement and may not specifically mention the goods that the business produces or the services that it offers. That may allow the business to be flexible when launching new products and services. A standard partnership also typically contains the business's start date.
Partner information and contributions
This section contains information about the creators of the partnership. This information is typically their names and contact information, such as addresses and phone numbers. The document also contains the nature and value of the contributions of each partner, whether money, property, asset, or labour. These contributions may determine their equity, which is the percentage of the capital that a partner has in the partnership asset. If any partner makes future contributions, this typically increases their capital account while any withdrawal decreases it.
Management and control
This section outlines each partner's ownership or percentage interest. While the allocation of profits and losses may not always equal the percentage of the equity each partner has, it's a common allocation method. For example, in a new partnership, one partner can give 75% of the business resources and the other 25%, but by bringing most of the market knowledge and skill. The partners may find it fair to distribute the profits equally.
Partner liabilities refer to the distribution of responsibility among partners for the debts and obligations of the business. This liability may differ between different types of partnerships. For example, in a general partnership, each partner has a total responsibility, meaning they're personally responsible for all the business's debts and obligations. That means creditors can act against any partner or more than one partner simultaneously if they're unable to pay their debts. Other partnership arrangements have their specific form of liabilities.
Meetings and voting rights
Clarifying the decision-making process of the business is crucial to the business's operations and may reflect in the partnership contract to avoid conflicts. For example, in a general partnership, each partner can enter into binding agreements, contracts, or business deals, and all other partners have an obligation to adhere to those terms. A binding agreement is a contract that is lawfully enforceable. Conducting regular meetings among partners can help avoid such situations. This meeting can be monthly or quarterly to discuss important decisions, such as entering into binding agreements and admitting new partners.
One crucial topic that partners can discuss is the voting rights of each partner. The partners may decide that a unanimous vote of all partners is essential for all significant business decisions, while individual partners can make minor decisions independently. What constitutes a major or minor decision can reflect on the agreement for easy referencing. With a limited partnership, the extent of the general partner's power can also reflect on the agreement to prevent them from making decisions that negatively affect the business or the other partners.
New partners and exits
In this section, the partners create specific guidelines for adding new partners and removing old partners. This can be necessary, as all businesses undergo changes. In many partnerships, the addition of new partners is by making contributions, but it can also be through buying the ownership interest of an existing partner. Adding new partners also often requires approval by current partners through a majority vote.
A partnership contract also often contains the guidelines for exiting members. These guidelines clearly outline the provisions for these members, whether they're leaving the partnership willingly or through death. The document also outlines the conditions for the dissolution of the partnership.
Types of partnership
There are generally three main partnership types, including:
A general partnership is the most basic type of partnership, as it's relatively inexpensive and straightforward to form. There are usually no legal requirements, and partners can create their business by signing a partnership document. The partnership also needs a registered trade name, registered tax number for applicable taxes, and a bank account to operate. This partnership empowers each partner to bind the business to contracts and loans and share responsibility for the business's debts and legal obligations. The general partnership also doesn't require a tax return, as taxation is personally on each partner's share of the partnership's income.
A limited partnership is another form of the general partnership. There's one general partner who's entirely responsible for the business and one or more limited partners who contribute capital but don't actively engage in the company's management. In some provinces, this partnership arrangement is only available to groups of professionals, such as lawyers, consultants, or doctors.
Four major characteristics distinguish a limited partnership from a general partnership, including:
Liability: In a general partnership, each partner shares the business liability, while in a limited partnership, there's a general partner with unlimited liability who has limited partners supporting them.
Profits: Usually, the single general partner receives a more significant share of the business' earnings due to the increased risk and contributions.
Management: While the limited partners can make capital contributions, they may not involve in the company's management as this is the primary responsibility of the general partner. A partnership document may outline the extent of the powers of the general partner.
Powers of the limited partners: The amount of capital that the limited partners contribute can determine their liability.
Limited liability partnership
A limited liability partnership gives the partners more liability protection than they may have as general partners. That means the partners are still fully responsible for the debts and legal liabilities of the business, but not for the errors and omissions of their fellow partners.
Suppose a creditor decides to sue the partnership for any given reason. In a limited liability partnership, only the partners' assets who worked with the creditor may be at risk, because this structure can protect the assets of the other partners. Limited liability partnerships (LLPs) are available in all provinces under provincial legislation. You may research each province to understand the level of protection it provides for establishing LLPs.
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