Login
Copyright

Creating a Business Partnership Agreement

An error occurred trying to load this video.

Try refreshing the page, or contact customer support.

Coming up next: Tax Structure and Liability of Business Partnerships

You're on a roll. Keep up the good work!

Take Quiz Watch Next Lesson
 Replay
Your next lesson will play in 10 seconds
  • 1:32 Partnership Agreement
  • 2:34 Business Decisions and…
  • 4:06 Profits and Losses
  • 5:09 Contracts and…
  • 6:24 Dissolving the Partnership
  • 7:23 Lesson Summary
Add to Add to Add to

Want to watch this again later?

Log in or sign up to add this lesson to a Custom Course.

Login or Sign up

Timeline
Autoplay
Autoplay
Create an account to start this course today
Try it free for 5 days!
Create An Account
Lesson Transcript
Instructor: Ashley Dugger

Ashley is an attorney. She has taught and written various introductory law courses.

Many businesses are partnerships. These are businesses owned by two or more people. This lesson explains how partnerships are created and the use of partnership agreements.

Partnerships

Many businesses are structured as partnerships. Partnerships are one of the oldest and most popular forms of business and are typically easy and inexpensive to form. A partnership is a for-profit business established and run by two or more individuals. The individuals are known as partners and serve as co-owners of the business.

Each partner is responsible for the business. This means that each partner must contribute something to the partnership, such as funds, property, skills or labor. Each partner also shares the business profits, liabilities and losses.

For example, let's say that Dottie and Dave decide to open a clothing store. Their store will be called D.D.'s Duds. Dottie and Dave are partners. They don't need to do anything special in order to form the partnership. Once Dottie and Dave agree to form the business, it's automatically a partnership.

The two decide that Dottie will be responsible for buying the clothing and stocking the store. Dave will be responsible for everyday store operations. They'll both contribute money toward funding the store, and they'll split any profits. If the store loses money, then they'll split the losses, too.

Partnership Agreement

Dottie and Dave don't need to file any special papers or forms in order to create their partnership. However, it would be wise for them to create a partnership agreement. This is a written agreement stating the terms of operation for the partnership. The agreement serves to protect the interests of each partner, as well as the business. Note that the agreement won't be enforceable unless it's in writing and signed by all partners.

A partnership agreement often includes:

  • How business decisions will be made
  • How the partners will resolve disputes
  • How the partners will divide profits
  • How the partners will cover losses
  • Who can legally bind the business through contracts
  • How ownership changes will be handled
  • How to dissolve the partnership

Let's take a separate look at each of these items.

Business Decisions and Disputes

Dottie and Dave should decide beforehand who's responsible for business decisions. Once D.D.'s Duds is up and running, Dottie and Dave won't want business decisions inhibiting workflow and profits.

For example, let's say that Dottie's responsible for all business decisions related to buying clothing and stocking the store. Dottie decides to stock half the store with Josie's Jeans because Dottie's convinced these jeans will be popular this season.

Dave sees the jeans and disagrees. He can't imagine these jeans will sell. Rather than arguing the point and delaying clothing shipments, risking an empty store, Dave submits to the agreement. Dottie is in charge of making this decision for D.D.'s Duds.

Dottie and Dave also need to establish how the partnership will resolve disputes. Let's say the jeans aren't selling. Since Dave's responsible for everyday store operations, he decides to sell the jeans at 50% off. Dottie disagrees and thinks Dave is sacrificing store profits to spite her. Should the two head to court to settle the dispute? Court procedures are lengthy and expensive.

Instead, Dottie and Dave should include a mediation clause in their partnership agreement. This clause mandates that the partners submit to mediation procedures and the decision of a mediator on any major disputes regarding the business.

Profits and Losses

Dottie and Dave should also document their agreement regarding the split of profits and losses. For example, let's say that both Dottie and Dave contribute funding toward the business in order to get the business started. Dottie contributes 60%, and Dave contributes 40%.

Accordingly, Dottie and Dave decide that Dottie will be a 60% owner of the business, and Dave will be a 40% owner of the business. They decide that Dottie will receive 60% of the store's profits, and Dave will receive 40%. Dottie, especially, has an interest in putting this agreement in writing.

Now, what about the business' losses? Normally, the losses are allocated according to ownership percentage. However, Dottie and Dave can agree on something different if they'd like. Let's say they decide to split the losses 50/50. They just need to include this arrangement in their written partnership agreement.

Contracts and Ownership Changes

Dottie and Dave next need to decide who has the authority to bind the business through contracts and when that authority may be exercised. For example, let's say neither Dottie nor Dave has the authority to bind the business to an obligation worth more than $10,000 without first obtaining the other partner's consent.

Let's say Dottie wants to order $20,000 worth of jeans for the store. Before Dottie orders so many jeans, Dave must first agree. This keeps either partner from obligating the business through risky or impractical deals.

The two should also decide what happens when a partner wants to leave the business. Dottie and Dave should include a buy/sell agreement in their partnership agreement. The buy/sell agreement should outline when and how a partnership can be transferred to another person.

Let's say Dottie wants to sell her 60% interest to her brother, Donnie. However, Dave doesn't want to be partners with Donnie. Hopefully, the partners included an arrangement where Dave can approve or deny the proposed new partnership or perhaps have the first right to buy Dottie's interest for himself.

To unlock this lesson you must be a Study.com Member.
Create your account

Register for a free trial

Are you a student or a teacher?
I am a teacher
What is your educational goal?
 Back

Unlock Your Education

See for yourself why 10 million people use Study.com

Become a Study.com member and start learning now.
Become a Member  Back

Earning College Credit

Did you know… We have over 95 college courses that prepare you to earn credit by exam that is accepted by over 2,000 colleges and universities. You can test out of the first two years of college and save thousands off your degree. Anyone can earn credit-by-exam regardless of age or education level.

To learn more, visit our Earning Credit Page

Transferring credit to the school of your choice

Not sure what college you want to attend yet? Study.com has thousands of articles about every imaginable degree, area of study and career path that can help you find the school that's right for you.

Create an account to start this course today
Try it free for 5 days!
Create An Account
Support