Creating a partnership agreement should be a top priority when launching a business with another person.
A partnership agreement is a contract between partners that explains each partner's rights and duties, how the partners will run the business, and how to end the partnership if necessary.
An effective partnership agreement contains numerous clauses related to running the partnership and how to resolve disputes between partners.
Common Clauses in Partnership Agreements
Most good partnership agreements contain the following clauses:
- The name of the partnership
- The partnership's goals
- How the partnership will operate, such as an LLC or a corporation
- The partners' names and addresses
- How partners participate in decision-making, such as how to decide whether to hire employees
- The partners' responsibilities
- What each partner contributed to the business
- Profit-sharing, including when and how to pay the partners, and in what percentage
- Where the partnership will operate, including the state and specific addresses, if known
- Hours of operation and vacation policies
- Whether the partnership is for a certain number of years—if it's not for a finite period, you can omit this, as the partnership will end when one or all partners decide to end it
- How to determine partners' liabilities for debts
- How to amend the agreement
- Procedures for adding new partners
- Which state's laws govern
- Whether partners must use arbitration or mediation before filing a lawsuit against each other
Additional Clauses to Make Your Agreement Solid
Adding the following clauses to your partnership agreement makes it more comprehensive and better for the partnership.
1. Buyout and dissolution clauses.
If you have buyout and dissolution clauses in your partnership agreement, you won't need to make a separate buyout or dissolution agreement with your partners should the partnership end.
Buyout clauses in the partnership agreement prepare for the possibility that the partnership will end at some point.
A buyout clause should contain at least the following:
- What event triggers the buyout, such as death, divorce, or retirement of a partner
- If the buyout must occur, or if there's an alternative
- Who can buy the partner out, such as whether the buyout only includes partners or permits buyouts by non-partners
- How to calculate payment to the outgoing partner
- If the partners can't agree upon a buyout, whether the partnership must dissolve, and if so, how to dissolve it, such as how to split assets and debts
2. A noncompete clause.
Noncompete clauses in partnership agreements are important because if your partnership dissolves, as a remaining partner, you don't want your former partner to open a competing business anywhere in the immediate area.
The problem with most noncompetes is two-fold—first, not all states accept them, and second, many of the clauses are overly restrictive. The more restrictive the clause is, the less likely a court will uphold it.
Check the law in your state to see if it allows noncompetes. If your state allows noncompete clauses, the more reasonable your clause is, the more likely a court will uphold it. After all, you can't deprive your former partner from earning a living.
If the clause limits the scope of the clause to a year or two, and to a small geographic area, such as no competing business within 10 to 30 miles, a court is more likely to enforce it. Likewise, if the clause requires the remaining partners to pay money to the outgoing partner, a court will likely uphold it because both parties benefit.
3. A nondisclosure clause.
Attorneys include nondisclosure clauses, or "NDAs," in partnership agreements to prevent partners from revealing confidential information intentionally and accidentally. It prevents partners from revealing "trade secrets" to others.
An NDA clause should specify what is and isn't confidential, how long the period of nondisclosure is, and who is bound by the clause. Many nondisclosure clauses last for two to five years from the date of the partnership agreement.
If anyone violates this clause, a partner can sue for damages or for an injunction to prevent them from further disclosing confidential information
4. Hiring people for the partnership.
It's important to include provisions in your agreement about whether to have employees, how the partners will select employees, and whether all partners must interview potential employees.
Likewise, it's helpful to have a clause that determines how to choose vendors, since the partnership will be dealing with technology providers and other types of vendors. Vendors often include marketers, attorneys, and accountants, in addition to suppliers.
5. What type of insurance the partnership requires.
The partnership needs appropriate and adequate insurance, such as fire, theft, liability, and sometimes life and disability insurance for the partners. The partnership could need additional insurance depending on the type of business it is. Specifying what insurance to buy is something to consider before starting your business.
While there are many clauses that could be included in a partnership agreement, these five are often omitted. Including them improves your agreement by adding specific terms that might require separate contracts, especially in the case of buyouts, dissolutions, noncompetes, and NDAs. The more specific you are in your partnership agreement, the more you can avoid headaches later on.