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A business partnership agreement is a written contract that establishes how partners will own, manage, and operate a business. Learn which terms to include, how ownership and profits are handled, what happens when a partner leaves or dies, and how a strong agreement can help prevent business disputes.
Starting a business with another person can be exciting, but shared ownership also creates legal and financial questions that should be addressed before problems arise. Who owns what percentage of the business partnership? Who can make major decisions? How are profits divided? What happens if one partner wants to leave? What if a partner dies, becomes disabled, stops contributing, or wants to sell their interest to someone outside the business?
A business partnership agreement is a written contract that establishes rules for how a partnership will operate and how the partners will handle important ownership, financial, management, and dispute-related issues.
Partnerships are generally a business structure in which two or more people own a business together. The U.S. Small Business Administration identifies general partnerships, limited partnerships, and limited liability partnerships as common partnership structures, although the legal rules governing them vary by state.
A partnership agreement can give the owners a framework for answering questions that might otherwise be governed by state default rules. The Revised Uniform Partnership Act, for example, supplies rules for partnerships in many jurisdictions and can apply when an agreement does not address a particular issue.
A well-prepared agreement does not guarantee that business partners will never disagree. Instead, it can establish procedures for dealing with disagreements before they become expensive or disruptive legal disputes.
A business partnership agreement is a legal document that sets out the rights, responsibilities, ownership interests, and obligations of business partners.
The agreement is generally created between the partners and is intended to govern the internal operation of the partnership. Depending on the business and applicable state law, it may address financial contributions, profit distribution, management authority, voting, ownership transfers, partner withdrawal, dispute resolution, and dissolution.
The exact contents depend on the partnership's structure and the partners' needs.
For example, two people starting a consulting business might agree that one partner will contribute most of the initial capital while the other contributes specialized expertise and manages daily operations. Their agreement could establish how profits are divided, which decisions require both partners' approval, and what happens if either partner wants to leave.
Without clear written terms, disagreements may have to be resolved under the partnership agreement if one exists, applicable state law, or both.
Whether a written partnership agreement is legally required depends on the type of partnership and the applicable state law.
Not every partnership needs a document simply because the owners have decided to operate a business together. However, the absence of a written agreement does not necessarily mean there are no legal rules governing the relationship.
State partnership statutes can supply default rules when partners have not agreed otherwise. The Revised Uniform Partnership Act, for example, governs partnership matters in many jurisdictions and addresses subjects such as partnership creation, liabilities, assets, fiduciary duties, and dissolution.
A written agreement can therefore be valuable even when the law does not require one.
It allows partners to make deliberate decisions about their relationship instead of leaving every unanswered question to statutory default rules.
The SBA also describes partnership agreements as internal documents that define how business decisions are made and establish partners' duties, powers, and responsibilities.
Partners may begin a business with a shared understanding of how everything will work. The problem is that verbal understandings can become unclear as the business grows.
One partner may believe that profits should be divided equally. Another may believe that the partner contributing more capital should receive a larger share.
One partner may expect to approve every major purchase. Another may assume that the person managing daily operations can make those decisions independently.
A written agreement provides an opportunity to address these issues in advance.
It can also establish procedures for situations that partners may not have considered when the business was first created.
For example, the agreement might address what happens if:
The goal is not to predict every possible future event. It is to create a framework for handling important events when they occur.
There is no single agreement that works for every business. The appropriate terms depend on the partnership's structure, industry, number of partners, assets, financing, and state law.
However, several provisions are commonly important.
The agreement should identify the partnership and the people entering into the agreement.
It may state:
The document should also be consistent with the partnership's formation documents and applicable state registration requirements.
The agreement should clearly identify each partner's ownership interest.
For example, three partners might own 50%, 30%, and 20%.
Ownership percentages can affect more than profits. Depending on the partnership structure and agreement, ownership may influence voting, distributions, capital accounts, buyouts, and the allocation of certain economic rights.
Partners should avoid vague statements such as "we all own the company together" when the actual ownership arrangement is more complicated.
Partners should document what each person is contributing to the business.
Contributions can include:
The agreement can identify the value assigned to contributions and explain whether partners are required to contribute additional capital later.
This can be especially important when partners contribute unequal amounts.
Suppose Partner A contributes $100,000 while Partner B contributes $25,000 but agrees to operate the business full-time. The partners should decide how those contributions affect ownership, compensation, distributions, and future funding rather than assuming everyone has the same understanding.
A partnership agreement should explain how profits and losses are allocated.
The partners might agree to an equal split, ownership-based percentages, or another arrangement permitted by applicable law.
The agreement should also distinguish between profit allocation and cash distributions.
A business can generate accounting profits without necessarily having enough cash to distribute immediately. Partners may decide to retain money in the business for taxes, payroll, expansion, equipment, debt repayment, or working capital.
The agreement can establish when distributions occur and who has authority to approve them.
Tax treatment also matters. Partnerships generally use pass-through taxation, meaning partnership income and losses can generally flow through to the partners' tax returns rather than being taxed at the partnership level in the same manner as a traditional C corporation. The specific tax consequences depend on the partnership and applicable tax rules.
Because partnership taxation can become complicated, partners should generally coordinate the agreement with qualified tax advice.
Partners should establish who is responsible for managing daily operations.
For example, one partner might handle:
Another might handle:
Clearly defining responsibilities can reduce confusion and make it easier to hold each partner accountable.
The agreement can also explain whether partners receive compensation for their work in addition to receiving their share of profits.
Decision-making provisions are among the most important parts of a partnership agreement.
Not every business decision needs the same level of approval.
The agreement might allow individual partners to make ordinary decisions within their assigned responsibilities while requiring approval from all partners for major actions.
Major decisions might include:
The agreement should explain whether decisions require a simple majority, a particular ownership percentage, unanimous approval, or another voting threshold.
This becomes particularly important in a two-person partnership.
If two partners each own 50% and disagree on a major decision, a deadlock can prevent the business from moving forward. A well-drafted agreement can establish what happens in that situation.
A partnership deadlock occurs when partners cannot reach the required agreement on an important business decision.
Deadlocks can be especially difficult in businesses with two equal owners.
Imagine two partners each own 50% of a company. One wants to expand into a new market while the other wants to conserve cash. If the agreement requires both partners to approve major investments, neither can move forward without the other.
A partnership agreement can establish a deadlock procedure.
Possible mechanisms may include:
The appropriate mechanism depends on the business and the partners' goals.
A partner's departure can create significant financial and legal questions.
The partnership agreement should explain whether a partner can voluntarily withdraw and what happens to their ownership interest.
For example, the agreement might establish:
Without clear provisions, a partner's departure can create uncertainty about the value of the departing partner's interest and the continuing partners' obligations.
The agreement can provide a predetermined process rather than requiring the partners to negotiate everything after the departure occurs.
The agreement can establish rules governing transfers of partnership interests.
Partners may not want an existing partner to sell their interest to an unknown third party without the other partners having a say.
A partnership agreement can therefore include transfer restrictions and procedures such as:
The precise effect of a transfer can depend on the partnership structure and state law.
A partner's economic interest and their ability to become or remain a full partner can also involve different legal questions.
This is another reason ownership-transfer provisions should be drafted carefully.
Death is an uncomfortable subject for business partners, but it is one of the situations that can create major disruption if the agreement says nothing about it.
A partnership agreement can establish what happens when a partner dies.
Depending on the structure and agreement, possible arrangements can address whether:
The agreement should be coordinated with the partner's estate plan.
For example, a person's will might leave their business interest to their children, while the partnership agreement restricts transfers to outsiders and gives the other partners a right to purchase the interest.
The documents should be reviewed together so they do not create unnecessary conflicts.
Long-term illness or disability can affect the operation of a business even when the partner does not formally leave.
A partnership agreement can establish what happens if a partner becomes unable to perform their responsibilities.
The agreement might address:
The exact provisions should be drafted with applicable state law and the partnership's circumstances in mind.
Business partners generally have legal duties toward the partnership and one another, and the exact rules vary by partnership structure and state law.
Partnership statutes can address fiduciary duties, including duties relating to loyalty and care. The Revised Uniform Partnership Act is one example of a statutory framework governing these relationships in many jurisdictions.
A partnership agreement can clarify expectations concerning matters such as:
Partners should understand that a contract cannot necessarily eliminate every legal duty imposed by applicable law. Some statutory rules may be mandatory or subject to limits on contractual modification.
Yes.
A partnership agreement may contain confidentiality provisions governing sensitive business information.
Depending on the business, confidential information could include:
Confidentiality provisions should clearly identify the information covered and the obligations of the partners.
If the business relies heavily on trade secrets or other intellectual property, additional agreements may be appropriate.
A partnership agreement may address competition and related restrictions, but enforceability can depend heavily on state law and the specific circumstances.
A provision restricting a departing partner from competing with the partnership, soliciting customers, or hiring employees may be treated differently from one state to another.
Courts can examine factors such as the language of the restriction, duration, geographic scope, legitimate business interests, and the circumstances surrounding the restriction.
Because restrictive covenants are highly jurisdiction-specific, partners should not assume that a non-compete clause will automatically be enforceable simply because everyone signed it.
The agreement should be reviewed under the law governing the partnership and the relevant relationship.
A partnership agreement can establish how disputes should be handled.
Common approaches include:
The partners first attempt to resolve the dispute themselves.
A neutral third party helps the partners attempt to reach a voluntary settlement.
A neutral arbitrator hears the dispute and issues a decision under the applicable arbitration agreement and rules.
The dispute is taken to court.
An agreement can establish whether the partners must attempt negotiation or mediation before beginning arbitration or litigation.
It can also identify the governing law and, where legally appropriate, the forum or location for resolving disputes.
A buy-sell provision establishes rules for transferring a partner's ownership interest when certain events occur.
Despite its name, it is not necessarily limited to a voluntary sale.
A buy-sell provision may apply when:
The provision can establish who has the right to purchase the interest and how the price will be determined.
Valuation can become one of the hardest issues when a partner leaves.
A partnership agreement can establish a valuation method in advance.
Possible methods include:
The right approach depends on the industry and business.
A valuation formula that works for a small professional practice may not work for a technology company, manufacturing business, or real estate partnership.
The agreement should also address disputes about valuation and payment terms.
A buyout does not necessarily have to be paid entirely at once.
Depending on the agreement and applicable law, the partners may structure payment through:
Payment terms can be particularly important when the business does not have enough cash to purchase a departing partner's interest immediately.
A buy-sell provision should therefore address both how much the interest is worth and how the purchase price will be paid.
If partners do not have a written agreement addressing a particular issue, applicable state partnership law may supply default rules.
The precise rules depend on the jurisdiction and type of partnership.
The Revised Uniform Partnership Act provides a framework for partnership matters in many states and can operate as a default set of rules when the partners' agreement does not address an issue.
This does not necessarily mean that the default rules are bad or unfair. It means the partners may have less control over how an unexpected situation is handled.
For example, if the partners never agree on how ownership should be valued when someone leaves, the applicable law and other legal principles may become important.
A written agreement gives partners an opportunity to make those decisions themselves, within the limits imposed by applicable law.
A partnership agreement and an LLC operating agreement serve similar internal-governance purposes, but they apply to different business structures.
A partnership agreement governs a partnership.
An LLC operating agreement governs an LLC.
The SBA describes an operating agreement as a document that establishes how an LLC's financial and functional decisions are made and defines members' duties, powers, and responsibilities.
The distinction matters because an LLC and a partnership can have different rules concerning liability, ownership, management, taxation, formation, and state compliance.
An LLC may also be taxed in different ways depending on its structure and elections, while a partnership generally receives partnership tax treatment unless another tax classification applies.
Business owners should therefore choose the legal structure first and then use the appropriate governing documents for that structure.
A partnership agreement should also not be confused with documents filed with the state.
Formation or registration documents provide information to the government about the business where filing is required.
A partnership agreement generally functions as an internal contract among the partners.
The SBA explains that limited partnerships and limited liability partnerships may have certificates or other state filing documents, while their partnership agreements establish internal rules concerning decisions, duties, powers, and responsibilities.
The exact filing requirements depend on the type of partnership and the state.
Adding a new partner can change ownership, management, voting, profit distribution, and tax considerations.
The partnership agreement should establish how new partners can be admitted.
The process might require:
The new partner should generally understand the existing agreement before becoming an owner.
Adding someone without properly documenting the change can create confusion about who owns what and who has authority to make decisions.
Partnership agreements can generally be amended when the partners follow the agreement's amendment procedures and applicable law.
The original agreement should explain how amendments are approved.
For example, the partners might require unanimous consent for major changes or a specified voting percentage for ordinary amendments.
Written amendments are generally preferable to informal verbal arrangements because they create a clear record of what the partners agreed to change.
The partners should also update related business records when appropriate.
Creating a partnership agreement generally starts with identifying the partnership's structure and the partners' expectations.
Determine whether the business is a general partnership, limited partnership, LLP, or another structure.
The legal consequences differ between structures, including issues involving liability and management.
List the partners and their ownership interests.
Specify what each partner contributes and whether additional contributions may be required.
Determine how profits, losses, and distributions will be handled.
Identify each partner's management role and authority.
Determine which decisions require individual authority, majority approval, or unanimous consent.
Create procedures for retirement, withdrawal, death, disability, and ownership transfers.
Determine how disagreements and deadlocks will be handled.
Explain when and how the partnership can be dissolved and how remaining assets and liabilities will be handled.
Partners should consider having a business attorney review the document before signing, particularly when the business has significant assets, intellectual property, employees, debt, or multiple owners.
Dissolution generally refers to the process of ending the partnership relationship and winding up the business.
The circumstances that can lead to dissolution vary by partnership structure and state law.
A partnership agreement can address events that may trigger dissolution and establish procedures for winding up the business.
The agreement may cover:
The goal is to make the end of the business as orderly as possible.
Even businesses that have written agreements can encounter problems if the document is incomplete or poorly coordinated.
A handshake may feel sufficient when partners trust each other, but memories and expectations can change.
Unclear ownership percentages can create serious financial and management disputes.
A 50/50 partnership should have a plan for resolving major disagreements.
If a partner leaves, the parties may disagree about what the ownership interest is worth.
Unexpected events can create major disruption when the agreement does not address them.
Management authority should be clearly defined so partners understand what decisions each person can make.
Profit allocations and distributions can have tax consequences that should be coordinated with the partnership's accountant or tax professional.
A partnership agreement created when the business had two owners may not work properly after the company grows, adds partners, takes on debt, or changes its operations.
A partnership agreement should be reviewed whenever there is a significant change in the business or ownership structure.
Examples include:
State laws governing partnerships can differ, and the SBA specifically notes that ownership, liability, taxes, and filing requirements can vary by state and business structure.
Regular reviews can help ensure that the agreement still reflects how the business actually operates.
A business lawyer can help partners identify legal issues that may not be obvious when they first start a business.
Professional advice can be particularly useful when:
A lawyer can also help determine whether the partnership structure itself is appropriate.
For example, general partnerships can expose partners to personal liability, while limited partnerships and LLPs have different liability structures. The SBA notes that general partnerships generally involve unlimited personal liability, while LLPs can provide limited liability to each partner under applicable state law.
Choosing the right structure is therefore a separate but related decision from drafting the partnership agreement.
A business partnership agreement is a written document that establishes the rules for how business partners will own, manage, and operate their business. It can address ownership percentages, capital contributions, profit and loss allocations, management responsibilities, voting, transfers, partner departures, disputes, buyouts, and dissolution.
Partnership agreements can be especially valuable because state partnership laws may provide default rules when partners have not addressed an issue themselves. The Revised Uniform Partnership Act, which has been adopted in many jurisdictions in various forms, provides a statutory framework covering important partnership matters.
A strong agreement should address not only how the business operates when everything is going well, but also what happens when circumstances change. Death, disability, retirement, disagreements, ownership transfers, financial difficulties, and a partner's decision to leave can all affect the future of the business.
Partnership law is not identical across the United States. The type of partnership, state law, tax treatment, and terms of the agreement can all affect the partners' rights and responsibilities. The SBA also notes that business structure requirements vary by state.
For that reason, partners should avoid treating a generic agreement as a substitute for legal advice. A carefully drafted agreement, reviewed when the business or ownership changes, can give partners a clearer framework for managing the business and addressing difficult situations before they become major disputes.
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