The Honeymoon is Over: Understanding the The Importance of Partnership Agreements

When two or more people enter into a business partnership (typically done through an LLC or Corporation, but can be done through general or limited partnerships), their main focus is on growing the enterprise and turning it from a concept into a successful creation. During this honeymoon period, everyone tends to feel energized and positive. They don’t take the time to define what it is they actually should be doing, preferring to keep their noses to the grindstone. They also seldom give much thought to the adverse or game-changing events that can and do happen.

For that reason alone, a partnership is one of those business arrangements that is best solidified and governed by a comprehensive partnership agreement.

When refer to a “partnership” in this article, we mean a business that is closely held by two or more parties (not necessarily a partnership as it is legally defined).  

What a Partnership Agreement (aka Operating Agreement in the LLC context or a Shareholder Agreement in the corporate context) Can Do

A partnership agreement is a contract that establishes the terms and conditions of the business relationship between the partners. Its purpose is to deal with every potential situation where there might be change, confusion, or disagreement, such as:

  • Ownership percentages
  • Profit and loss distribution
  • Establishing the tax rules between the partners
  • Establishment of a managing partner
  • The roles, authority, and responsibilities of each partner, as well how both can change
  • Circumstances under which new partners can join
  • Steps for dealing with unforeseen events (e.g., death and disability)
  • Steps for dealing with disputes or failures by a partner to abide by the agreement
  • Steps for terminating the partnership
  • The length of the partnership

Without an agreement in place, the default rules of the state in which the company exists will govern the partnership, and these guidelines might not be compatible with how the partners intend to run the business.

Situations a Partnership Agreement Can Plan For

Partnership agreements better enable everyone to handle the problems that can arise even in the strongest and most amicable business relationships. A set of clear rules can prevent a minor dispute from escalating into a serious issue that spells the end of the partnership. For example:

  • Addressing partnership changes caused by normal life challenges. The partners can create contingency plans that cover what to do if a partner gets divorced, becomes mentally or physically incapable of fulfilling their responsibilities, goes bankrupt, dies, or simply decides to leave.
  • Setting up specific rules about when one partner can choose to sell their ownership stake in the company
  • Spelling out the individual liability of each partner and how a liability issue with one partner can affect the others.
  • Resolving partner disputes over issues like non-compete agreements and conflict of interest

Although a written partnership agreement is not a legal requirement in Colorado, it does provide the advantage of allowing the partners to decide how to make business decisions, distribute profits and losses, and deal with issues that could be detrimental to the partnership, giving the enterprise the best possible chance at future growth and success.  In my humble opinion, when more than 2 people are in business together, a partnership agreement is absolutely necessary.

If you own a business along with one or more other people in Colorado and need assistance in drawing up a partnership agreement, contact Doida Law Group today. We will help you consider and customize an agreement that will protect each partner’s investment while preserving the operating efficiency of the business.

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