Partnership agreements are written documents that explicitly detail the relationship between the business partners, as well as their individual obligations and contributions to the partnership. Since partnership agreements should cover all possible business situations that could arise during the life of the partnership, the documents are often complex, and legal counsel in drafting and reviewing the finished contract is generally recommended. If a partnership does not have a partnership agreement in place when it dissolves, the guidelines of the Uniform Partnership Act and various state laws will determine how the assets and debts of the partnership are distributed.
RECOMMENDED ELEMENTS OF THE PARTNERSHIP AGREEMENT
1. Name and address of partnership
2. Duration of partnership—Partners can point to a specific termination date or include a general clause explaining that the partnership will exist until all partners agree to dissolve it or a partner dies.
3. Business purpose—Some consultants recommend that partners keep this section somewhat vague in case opportunities for expansion arise, while others, such as Legal Handbook for Small Business author Marc J. Lane, feel otherwise: "Avoid any conflict in entrepreneurial goals. Since a general partnership obligates you for the business acts and omissions of your copartners, it is wise to limit the scope of your business activities by contract."
4. Bank account information—This section should note which bank accounts are to be used for partnership purposes, and which partners have check-signing privileges.
5. Partners' contributions—Valuation of all contributions, whether in cash, property or services.
6. Partners' compensation—Determine in detail how and when profits (and salaries, if applicable) will be distributed.
7. Management authority—What are the operational responsibilities of each partner? Will partners be able to make some decisions on their own? Which decisions will require the unanimous consent of all partners? What are the voting rights of each partner? How will tie votes be resolved?
8. Circumstances under which new partners might be admitted into the partnership.
9. Work hours and vacation.
10. Kinds of outside business activities that will be allowed for partners.
11. Disposition of partnership's name if a partner leaves.
12. Dispute resolution—Stipulates what kinds mediation or arbitration will be utilized in the case of disputes that cannot be resolved amongst the partners. This is a way to avoid costly litigation.
13. Miscellaneous provisions—This portion of the agreement might delineate the circumstances under which the agreement could be amended, for example.
14. Buy-Sell Agreement.
THE BUY-SELL AGREEMENT The buy-sell agreement is one of the most important elements of any partnership agreement. It details what will happen to the partnership if one of its partners leave the business. In essence, it specifies the terms of a buyout in the event of death, divorce, disability, or retirement. "Having a buy/sell agreement in place makes a great deal of difference," commented Mary Rowland in Nation's Business, "to guarantee the smooth transition of a business and ensure that it need not be sold at an inopportune time." Indeed, the importance of this particular element of the partnership agreement is underlined by the fact that in recent years, loan institutions, companies that provide bonding for construction jobs, and other outside firms have begun to insist that small business clients have buy/sell agreements in place.
The two primary structures for buy/sell agreements are cross purchase agreements, in which the remaining partnership owners buy the departing partner's stock or partnership interest, and the stock redemption agreement, in which the company buys the stock of the departing owner. The advantage of the cross purchase agreement, wrote Rowland, is that "the purchasers get a tax saving 'step up' in basis to the market value of that portion of the business…. With a cross purchase agreement, the owners typically buy life insurance policies on one another to finance the agreement. If there are just two owners, it's pretty straightforward," but with multiple shareholders, this arrangement can get confusing and expensive.
With stock redemption agreements, on the other hand, "the company would own the life insurance policy and pay the premiums," said Rowland. "An advantage to this type of agreement is that if there are a number of owners, only one policy on each is necessary." Disadvantages of this type of buy/sell agreement include absence of 'step up' savings and the fact that in cases where the life insurance used to finance the redemption agreement is owned by a business structured as a C Corporation, the company might be liable for the alternative minimum tax (AMT) on any proceeds.