Why Create An Agreement?
Similar to a sole proprietor, a partnership shoulders the majority of the risk when opening a new venture (unlike limited liability models). As a result of this, partners entering an agreement will want to consider creating a partnership agreement, which governs the nature of their relationship relative to the venture they are collaborating on.
For example, let's assume that a startup company decides to formulate their business as a partnership between four people. They estimate that $100,000 will be required to get the business off the ground over the next two years. They agree to invest equally, and write in the contract that each individual will contribute $25,000. However, after the first two years, one member fails to contribute. This voids the contract with that partner, and the overall ownership of the business now rests with the individuals who fulfilled the contract.
Common Partnership Agreement Components
The above example is fairly simple. However, businesses encounter a wide variety of challenges in which contractual agreements can be useful. Here are a few common components of partnership agreements:
- Majority Management - This indicates that business decisions will be made through the authorization of the majority of partners, protecting partners from one individual partner controlling the entire organization.
- Annual Account - This obligates each partner to collaboratively settle organizational accounts and debts each year.
- Consistent Interest - As partnerships are often side projects, this obligates each partner to a certain amount of interest and/or time commitment in the venture.
- Resolution of Dispute - It is often a good idea to anticipate which types of disputes may arise, and denote standard practices for how these disagreements will be handled.
- Causes Income Losses - If the company is not achieving the expected profitability, this will scale down the compensation received by each partner relative to the business's overall success.
- Misconduct Expulsion - At times, it may be necessary to remove one partner due to poor behavior. An example of this may be one partner spending far too much on business expenses, such as flying first class and abusing shared resources.
While there may be many more aspects of a partnership agreement depending on the specific type of business, and the needs of each partner, this list is a good tool in understanding the general logic behind such agreements. When entering a collaboration, it is important to consider what could go wrong before it goes wrong, and plan for how to handle that contractually.