As an entrepreneur, doing business alone can make the road seem hard and lonely. Having a second (third or fourth) set of eyes or a person to run things by can make your business easier and more fun. That’s why choosing a partnership business structure could be the choice for you.
However, it’s estimated that 80 per cent of partnerships will fall apart, so it’s important you protect yourself before that happens. That’s where a partnership agreement comes into play. It can help you protect you and your business in the long run, should things not work out.
What is the main purpose of a partnership agreement?
Partnerships can be complex, especially in Canada, where they’re two or more sole proprietors who have banded together. Partnership agreements can help mitigate their complexity by ironing out the details of the business arrangement.
The agreement is a written document between the two or more parties undertaking that business venture together. It outlines the rules, responsibilities, and relationship between the individuals participating in the partnership.
Importance of a partnership agreement
The primary importance of a partnership agreement is to help resolve conflicts before they arise. By clearly outlining the responsibilities and relationship, an agreement can help fend off disputes over details like ownership, roles, and termination of the arrangement. In the long run, this can help save everyone involved money and avoid lengthy court cases by making dispute resolution simpler.
Benefits of a partnership agreement
Business partnership agreements have some serious benefits if you’re planning to go into business with someone else. It helps you establish the business officially, and reduce the potential for issues in the future.
Establishing decision-making process
It’s not uncommon for disagreements to arise in a partnership, so having an agreement right off the bat can help establish who has what say when making a decision. Even if you have a 50/50 partnership where each partner has an equal vote, a partnership can establish the process for a third-party to provide a swaying vote. But partnerships don’t have to be 50/50, it can be established on whatever grounds the partnership agreement lays out.
Reduce money-related disputes
Most partnerships see an equal share of profits and liabilities to each partner, but this division could lead to an issue where one partner has committed more time or money than the others. Your arrangement doesn’t have to adhere to the status quo, your partnership agreement can stipulate a different divide based on specific contributions.
A partnership agreement plays an important role in helping to combat these money-related disputes before they happen by establishing boundaries and rewards based on contribution. Plus, they make sure you get paid. That same agreement can also serve to limit the liability of partners based on their contributions as well.
Avoid legal battles
Lawyers are expensive, especially when something goes to court. While the best partnership plans are drawn up by lawyers, thus requiring a fee, that cost is likely to be significantly less than if you ended up in a court battle over something that could have been outlined with a good partnership agreement.
Not only can it outline the business relationships and awards, a partnership agreement can stipulate cheaper alternative resolutions for disputes, like mediation, negotiation, or arbitration. Saving you both time and money.
Create an entry plan
Without setting out an entry plan in a partnership agreement, any partner could theoretically be added to a business. By adding an entry plan in the initial partnership agreement, you can protect the partnership from unwanted prospective partners.
It doesn’t just outline how new partners are onboarded, but how much of a stake in the company they’re entitled to, what they have to put forward, and what kind of say a new partner has in the overall business.
Set up an exit plan
With no agreement in place, any partner can terminate or dissolve the partnership at any time—no real warning needed. But the right partnership agreement helps define an exit strategy for each of the outgoing partners. An exit plan can outline circumstances, processes, and other important information. It can also establish an overall process in the event all the partners agree to end the partnership.
Disadvantages of a partnership agreement
Creating a partnership agreement doesn’t mean your business relationship will be all rosy. While signing one protects you and helps firm up the relationship between partners, it also has some drawbacks.
Increased liability
Not only do all partners share in the business profits and losses, but they also have increased liability. You are no longer just responsible for your own actions, but also those of your partners’. That means that if one of you gets sued, you could be at risk.
Less autonomy
When you’re a solo operator, you get to make all the decisions. But with a partner, you lose the ability to make all the decisions for the business—there will be compromise and concessions. Before you sign a partnership agreement, you want to make sure that you can live with that.
Elements of a partnership agreement
When you set up your partnership agreement template, there are certain elements you’ll want to make sure you include. Everything from your ownership percentage to the length of the partnership can be included in the agreement—this can make the entire partnership easier in the long run.
Ownership percentage
One of the most important things that a partnership agreement outlines is who owns what. While 50-50 business partnerships seem like the default, there are several factors to consider, including:
- Financial contribution
- Equipment contributions
- Service contributions
How partner contributions are evaluated is up to you and your partner or partners. But it’s important that contributions and ownership percentage are included in the agreement.
Decision making and dispute resolution
Having more than one cook in the kitchen, or partner making decisions, can make things a little more complex. But a partnership agreement can help outline what happens. This is important for big decisions, especially those that might include financial matters. It helps put checks and balances in place and often includes a mediation clause to resolve disputes.
Division of profit and loss
Just because you have a certain percentage of ownership doesn’t mean that the profit-and-loss distribution has to be divided up the same way. Partners could choose to share the profits and loss equally, even if the ownership isn’t equal. It’s necessary to outline profit and loss, and ownership separately so it doesn’t become a problem down the line.
Length of partnership
While your partnership can exist for an undetermined amount of time, a partnership agreement can lay out the terms where it can be dissolved earlier. For instance, if you want to end the partnership after you reach a milestone or certain period.
Authority
Binding power or partnership authority outlines who within the agreement has the authority to bind the business to a debt or contractual agreement.
Not having this properly outlined within the agreement means that one partner could commit the entire partnership to a contract that they aren’t able to uphold, leaving everyone in a bind and liable.
Partnership end
The departure of a partner is something that needs to be worked out ahead of time. Not only what happens when a partner decides to leave but also what happens when a partner dies. This often includes something like a buy and sell agreement.
When to use a partnership agreement
Business partnership agreements should be used anytime you’re joining forces with someone else on a business venture.
Going into business with another person or persons can be rewarding, but there are some risks involved. A partnership agreement can help you firm up the details and combat difficulties before they happen.
Protect yourself and protect your business before it needs it. And if you’re ready to set up your sole proprietorship before you get into a partnership, Ownr is here to help you out. If you want to go bigger, we can also help you incorporate as well!
This article offers general information only, is current as of the date of publication, and is not intended as legal, financial or other professional advice. A professional advisor should be consulted regarding your specific situation. While the information presented is believed to be factual and current, its accuracy is not guaranteed and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author(s) as of the date of publication and are subject to change. No endorsement of any third parties or their advice, opinions, information, products or services is expressly given or implied by RBC Ventures Inc. or its affiliates.