Starting a business with someone else can be exciting.
You may have complementary skills, shared goals, and a strong idea that you both believe can succeed. One partner might handle sales while the other manages operations. Another partnership might bring together a designer and a marketer who want to build an agency.
However, good intentions aren’t always enough to keep a business partnership running smoothly.
Questions can eventually arise:
- Who owns what percentage of the business?
- How will profits be divided?
- Who makes important decisions?
- What happens if one partner wants to leave?
- What if a partner stops contributing?
- Can a partner sell their share?
- What happens if the business closes?
A business partnership agreement helps answer these questions before they become major problems.
In simple terms, it is a written agreement that explains how business partners will work together, share responsibilities, handle money, make decisions, and deal with changes in the partnership.
Let’s look at what a partnership agreement means, what it should contain, and why creating one can be an important step when starting a business with someone else.
What Is a Business Partnership Agreement?
A business partnership agreement is a written contract between two or more business partners that establishes the rules for operating their partnership.
It can explain matters such as:
- Each partner’s ownership interest
- Financial contributions
- Profit and loss distribution
- Responsibilities
- Decision-making authority
- Management duties
- Dispute resolution
- Adding new partners
- Partner withdrawal
- Business dissolution
The exact requirements and legal effects of a partnership agreement vary depending on the country, state, province, business structure, and other circumstances.
For that reason, a general online template should not automatically be treated as a complete legal document for every business.
The basic idea, however, is straightforward:
Put important expectations in writing before disagreements happen.
Why Is a Partnership Agreement Important?
You might wonder why you need a formal agreement if you already trust your business partner.
Trust is valuable, but a written agreement provides clarity.
When everything is going well, partners may naturally agree about most decisions.
Problems often appear when circumstances change.
For example, one partner might want to expand the business while another wants to keep it small. One may want to withdraw money from the company while another wants to reinvest profits.
Without clear rules, disagreements can become difficult to resolve.
A partnership agreement gives you a framework for handling these situations.
It Clarifies Expectations
Everyone understands their responsibilities from the beginning.
It Reduces Confusion
Partners don’t have to rely entirely on verbal promises or assumptions.
It Helps Manage Disagreements
The agreement can establish how certain disputes should be handled.
It Provides a Plan for Major Changes
The document can explain what happens if a partner leaves, becomes unable to participate, or wants to sell their interest.
It Protects the Business Relationship
Clear expectations can reduce misunderstandings between people who are working closely together.
What Should a Partnership Agreement Include?
There is no universal agreement that works for every partnership.
However, a well-prepared document often addresses several important areas.
1. Business Information
Start with basic information about the partnership.
This can include:
- Business name
- Business address
- Purpose of the partnership
- Names of the partners
- Effective date of the agreement
You should also clearly identify the legal structure under which the business operates.
2. Ownership Percentage
The agreement should explain how ownership is divided.
For example:
Partner A: 60%
Partner B: 40%
Ownership percentages can affect profit distribution, voting rights, and other matters depending on the business structure and agreement.
Don’t assume that equal ownership is automatically the right choice.
Partners may contribute different amounts of money, intellectual property, equipment, experience, or ongoing work.
The ownership arrangement should reflect what the partners have actually agreed upon.
3. Financial Contributions
Partners may contribute money or other assets when starting the business.
The agreement can specify:
- How much each partner contributes
- When contributions are due
- Whether additional contributions may be required
- How additional funding will be handled
- Whether contributions affect ownership
For example, one partner might contribute $20,000 while another contributes $10,000 plus specialized equipment.
Documenting these contributions can prevent disagreements later.
4. Profit and Loss Sharing
Partners should decide how profits and losses will be allocated.
It doesn’t always have to be exactly the same as ownership percentages, depending on the legal structure and applicable rules.
For example, partners might agree to divide profits:
Partner A: 60%
Partner B: 40%
The agreement should explain how distributions work and when partners can take money from the business.
This is particularly important because business revenue and personal income are not necessarily the same thing.
5. Roles and Responsibilities
Clearly define what each partner is expected to do.
For example:
Partner A
- Sales
- Marketing
- Client relationships
Partner B
- Operations
- Finance
- Supplier management
You don’t need to predict every task.
Instead, identify the major areas of responsibility and management authority.
This can prevent one partner from assuming that the other will handle something.
6. Decision-Making Rules
Decision-making can become one of the biggest sources of conflict in a partnership.
Your agreement should explain how important decisions are made.
For example:
- Ordinary decisions may require a simple majority.
- Major decisions may require approval from all partners.
- Certain financial decisions may require a specific voting threshold.
Important decisions might include:
- Taking on significant debt
- Buying or selling major assets
- Hiring senior employees
- Entering a new market
- Changing the business structure
- Selling the company
The exact rules should reflect the size and structure of your business.
7. Partner Compensation
Partners should distinguish between business profits and payments for work performed.
For example, a partner who manages the company full-time may receive compensation for their work in addition to their share of profits, depending on the business structure and applicable law.
The agreement can explain:
- Whether partners receive salaries or other compensation
- How compensation is determined
- When payments are made
- How expenses are reimbursed
Because tax treatment varies by jurisdiction and business structure, professional accounting advice can be useful when setting up these arrangements.
8. What Happens If a Partner Wants to Leave?
Addressing this matter is of utmost importance and should not be overlooked.
Imagine that your partner decides to leave the business after several years.
What happens to their ownership interest?
A partnership agreement can establish rules for:
- Voluntary withdrawal
- Selling an ownership interest
- Valuing the departing partner’s share
- Payment terms
- Transfer restrictions
- Notice requirements
Without a clear process, the departure of one partner can create significant uncertainty.
9. Death, Disability, or Inability to Participate
Unexpected situations can also affect a partnership.
Your agreement can explain what happens if a partner dies or becomes unable to continue participating in the business.
Depending on the circumstances, the agreement may address:
- Transfer of ownership
- Purchase of the partner’s interest
- Rights of heirs
- Business valuation
- Insurance arrangements
- Management continuity
These topics may feel uncomfortable to discuss when starting a business, but planning ahead can make difficult situations easier to manage.
10. Dispute Resolution
Even good partners can disagree.
A partnership agreement can establish a process for resolving disputes.
For example, partners might agree to attempt:
- Direct discussion
- Mediation
- Arbitration, where appropriate
- Court proceedings if other methods fail
The appropriate approach depends on the agreement, jurisdiction, and nature of the dispute.
The goal is to avoid having every disagreement turn into an immediate legal battle.
What Happens Without a Partnership Agreement?
This is an important question.
If partners don’t create their own written agreement, default partnership laws may determine certain aspects of how the business operates.
The standard rules might not align with the true intentions of the partners involved.
For example, partners may assume they will divide profits in a particular way, only to discover that applicable default rules produce a different result.
The exact consequences depend heavily on the jurisdiction and business structure.
This is one reason it’s worth documenting important decisions instead of relying on informal conversations.
Partnership Agreement vs. Operating Agreement
These terms are sometimes confused.
A partnership agreement is generally used to establish the terms between partners in a partnership.
An operating agreement is commonly associated with limited liability companies, or LLCs, and describes how the LLC is managed and operated.
The appropriate document depends on the legal structure of the business.
For example:
- General partnership -> partnership agreement
- Limited liability partnership -> partnership-related agreement and applicable governing documents
- LLC -> operating agreement
- Corporation -> corporate governance documents, shareholder agreements, and related documents
The names and requirements can vary by jurisdiction.
Before choosing a document, make sure you know what legal structure your business actually has.
How to Create a Business Partnership Agreement
Creating the agreement doesn’t have to start with complicated legal language.
Begin with a conversation.
Step 1: Discuss Your Expectations
Talk openly about money, responsibilities, ownership, goals, and decision-making.
Step 2: List Potential Problems
Ask difficult questions.
What happens if someone wants to leave?
What if the business loses money?
What if one partner stops working?
What if you disagree about selling the business?
Step 3: Write Down the Decisions
Turn your discussions into clear terms.
Step 4: Review the Agreement
Each partner should have an opportunity to review the document independently.
Step 5: Get Professional Legal Advice
For a real business partnership, having a qualified lawyer review the agreement can help identify issues you may have missed.
Step 6: Sign and Store the Agreement
All partners should receive a copy and know where the current version is stored.
Common Mistakes to Avoid
Creating an agreement is helpful, but a poorly prepared agreement can still cause problems.
Relying on a Generic Template
Templates can provide a starting point, but they may not address the specific requirements of your business or jurisdiction.
Avoiding Difficult Conversations
If you can’t discuss what happens when a partner leaves, it’s even more important to address it before starting.
Leaving Responsibilities Vague
“Both partners will manage the business” may not be specific enough.
Clearly identify major areas of responsibility.
Ignoring Future Changes
Businesses evolve.
Your agreement should provide a process for dealing with new partners, ownership changes, additional investment, and other significant developments.
Forgetting About Disputes
Assuming you’ll never disagree isn’t a strategy.
A dispute-resolution process can make future disagreements easier to handle.
When Should You Create a Partnership Agreement?
Ideally, create and finalize the agreement before you begin operating the business together.
Don’t wait until there’s already a disagreement.
If your partnership is already operating without a formal agreement, it’s still worth discussing whether one should be created.
You can also review an existing agreement when:
- A new partner joins
- A partner leaves
- Ownership changes
- The business expands
- The business structure changes
- Major responsibilities change
- The company takes on significant investment or debt
Legal and business circumstances can change, so an agreement should be reviewed when major events occur.
Conclusion
A business partnership agreement is more than a document filled with legal terms.
It is a practical roadmap for how partners will work together.
By clearly documenting ownership, contributions, responsibilities, profits, decision-making, partner departures, and dispute procedures, you can reduce uncertainty and establish expectations from the beginning.
The best time to discuss difficult partnership questions is before they become difficult.
If you’re planning to start a business with another person, take the time to discuss what each partner expects and put those decisions in writing. For an actual business arrangement, consider having a qualified lawyer review the final agreement so it fits your business structure and local laws.
Frequently Asked Questions
1. Is a business partnership agreement legally required?
The requirement depends on the jurisdiction and type of partnership. In some situations, a partnership can exist without a written agreement, with default laws governing certain matters. However, having a written agreement can provide much greater clarity.
2. What is the main purpose of a partnership agreement?
Its main purpose is to establish clear rules for how partners will own, manage, finance, and operate the business and how major changes or disputes will be handled.
3. Can partners have different ownership percentages?
Yes. Partners can agree to different ownership percentages, subject to the applicable legal structure and laws. The agreement should clearly document the arrangement.
4. What are the procedures if a partner decides to exit the partnership?
The agreement can establish a process for withdrawal, valuation of the partner’s interest, transfer restrictions, and payment arrangements. If there is no agreement, applicable law and the circumstances of the partnership may determine what happens.
5. Can I write my own partnership agreement?
You can draft an agreement, but a qualified legal professional should review it when possible, especially when the business involves significant money, assets, intellectual property, employees, or complex ownership arrangements.
6. Should a partnership agreement be updated?
Yes. It’s sensible to review the agreement when there are significant changes to ownership, management, business structure, investment, or partner responsibilities.