Why You Need a Partnership Agreement

When you form a partnership to run a small business, your partners will probably be family members, close friends, or business associates. You may think it's unnecessary to enter into a formal agreement with people you know quite well. Experience proves otherwise. No matter how rosy things are at the beginning, every partnership inevitably faces problems over the years. A well-thought-out written agreement will help you preserve the business, as well as your friendships.

If you don't sign an agreement, you can still have a legally valid partnership. The laws of your state will dictate how that partnership is run. Every state except Louisiana has adopted either the Uniform Partnership Act (UPA) or the Revised Uniform Partnership Act (RUPA). States have sometimes made slight variations in these laws but there is a remarkable amount of consistency from state to state.

These state laws solve many common partnership problems in a sensible way. For example, the UPA says that if you don't have an agreement, each partner shares equally in the profits and has an equal voice in managing the business. In addition, under the UPA, partners are not entitled to receive compensation for services they provide to the partnership.

Although it's possible that your state law provides exactly what you and your partners want, it's usually better to create your own agreement. And you'll probably want to modify at least some of the terms. For example, if one partner contributes more assets than the others, you may want to give that partner a greater share of the profits. Or you may want to allow one or more partners to receive a salary for their services. You may want to include customized provisions on how to value a partner's interest in the business if a partner dies or leaves. In that situation, many partners want to assign some value to the goodwill of the business for tax purposes—something that does not happen automatically under the UPA. With a written partnership agreement, you can tailor your partnership to fit your needs.

There are other benefits to working out the details in a written partnership agreement. It will get you to focus on issues you might not have thought through with your partners—issues that you and your partners may not agree on. For example, what if one partner wants compensation beyond a share of the profits to recognize work he or she performs in the evening or on weekends for the partnership? By getting issues out into the open early, you can nip potential problems in the bud.

Most Partnership Information Is Confidential

The terms of a partnership agreement for a general partnership don't have to be made public. But, in some states, you must file a certificate of partnership, stating the names of the partners, with a county official (such as the county clerk) or state official (such as the secretary of state).

Excerpted from Legal Guide for Starting & Running a Business, by Fred Steingold (Nolo).

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