Pros and Cons of Partnership Agreement
By Joanne Hue, Updated: 2023-03-22 (published on 2023-01-02)
Every business has its own goal and the path or plan to achieve the goals will vary. For those who want to grow their business with more support from the inside, looking for a partner can be one such way. However, before moving ahead with it, it is important to define the relationship and structure of the partnership. While it can provide businesses with the required support and resources to grow more, it can also lead to more internal disagreements and slow the growth of the company. So, it is important to consider your goals, and your potential partner’s vision and weigh the pros and cons of a partnership agreement before you sign one. Here are a few things to be clear of before moving ahead.
What is a Partnership Agreement?
Any agreement between two or more company partners is referred to as a partnership agreement. When you sign a partnership agreement, your agreement serves as a framework for your – and your partners’- rights, obligations, and profit-and-loss allocation. Additionally, the agreement specifies general partnership guidelines for things like capital contributions, withdrawals, and financial reporting.
A partnership agreement is intrinsic to a partnership exchange as it outlines the duties and rights of each partner. Furthermore, it provides the partners with an opportunity to create their own conditionalities. This permits more autonomy in the business exchange.
Even though it may be legal to operate without a partnership agreement, there are benefits to creating one. This is because, in the lack of a partnership agreement, your exchanges are governed by the available transaction laws in your nation.
For instance, the Revised Uniform Partnership Act is followed by 37 states in the USA. However, it contains elements that could be inappropriate for specific forms of partnership. By drafting your own partnership contract, you have the liberty to decide the particulars of your business. You may also alter the relevant framework to adequately suit your business.It’s not always necessary for a partner to be an individual. A corporation or another type of business entity can also be a partner. A partnership agreement allows you to define the legal status of your partnership.
Types of Partners in a Partnership
Depending on the partnership, there are various types of partners:
- Salaried and Equity Partners: While some partners in a partnership receive salaries, equity partners own a stake in the company.
- Partners with varied levels: Equity partners own a stake in the company, whilst some partners in a partnership receive salaries.
- General and limited partners: The partners that participate in management-related duties and hold debt liabilities are general partners. In contrast, limited partners, make investments in the company without taking part in management decisions.
What are the Pros of a Partnership Agreement?
Partnership Agreements form a contractual obligation with your partner. Your partner may be an individual or a business. Either way, it is difficult to monitor whether the partnership is being performed diligently without an agreement. A Partnership Agreement has the following pros:
- Reduction in probable disputes: When the responsibilities of each party are explicitly outlined, the probability of disputes that may arise in the future reduces.
- Defines expectations: A partnership creates an exchange of responsibilities. Making a partnership agreement establishes the expectations of each party. the parties setting out the expectations for the parties regarding the operation and management of the business;
- Financial advantages: The investments in a partnership are distributed. Formulating a partnership agreement contractually solidifies it. This lessens the financial burden on a startup program.
- Access to capital: Due to the number of parties and investors involved in a business, it need not seek outward capital. The process of borrowing and exchanging money becomes much more convenient in a partnership. It also aligns the interests of the parties involved, making the transaction more reliable.
- Opportunity to split income: A partnership agreement seeks a long-term exchange between the parties. Meaning, the party that may have suffered a greater loss can be compensated through income splitting.
Limited external regulations: A partnership agreement allows the partners to create and levy conditions that are the most mutually favorable. This allows for business autonomy and limits external regulations.
What are the Cons of a Partnership Agreement?
Before entering a partnership agreement with another party, you need to be aware of its cons: :
- Joint Debt Liability: Each party to a partnership agreement is jointly and severally liable for the debts of the other party.
- Liability in Action: Financial obligations are only one aspect of liabilities; each party is also liable for the acts of the other. Meaning that a partner’s reputation may suffer if other parties are associated with them.
- Unlimited Liability: Partner liability is unlimited, as opposed to shareholder liability, which is limited.
- Shared Profits: According to the terms of the partnership agreement, profits must be distributed to the other partners. For the partner who would invest more money or make more money, this may not be the best situation.
- Disputes: The interests may change as the partnership develops. There is a chance that the parties will disagree as a result of this. The party that gains more benefits from the partnership may be particularly harmed by a dispute.
Financial Caution: The assets of the partnership will likely need to be valued if a partner enters or departs. This can be an expensive process, and it might cause the partner company to lose its assets or safety net.
Should you partake in a Partnership Agreement?
The partnership agreement can be exceptionally beneficial to a business. However, the advantages and disadvantages of the agreement are highly reliant on the status quo of your business, your partners, the capacity to fulfill contractual responsibilities, and the quality of the contract. Therefore, before signing a partnership agreement there are factors that you have to keep in mind.
You need to be cautious to not skip important details in the agreement. You cannot trust that an agreement will always go according to your intention or the intentions of your partner. Observing your agreement through a highly optimistic lens may not always be the best option. Your partnership agreement should be able to address the problems that may arise in the future.
Partnership agreement and their implications are greatly variable depending on the legal provisions of your state and the state of your partner. Make sure to acquire adequate legal counsel before entering into an agreement.
Likewise, it is vital to readily make amendments to your partnership agreement as your partnership evolves. This will help address the changing interests of your company. Finally, with the evolution of your partnership, you need to compartmentalize your liabilities with the formation of new ventures with your partners. This will prevent complications in understanding developments in newer business ideas and related partnerships with the same partner. It is essential to obtain legal and financial counsel before entering into a partnership agreement.
How do you create a partnership agreement?
The decision to enter into a partnership agreement is dependent upon your company and your prospective partners. Since a partnership agreement is formed by a legal contract, it creates binding obligations for you and your partner. Therefore, it ought to be worded cautiously and should be signed by all the parties involved.
In order to create a partnership agreement you can easily select available templates and create the one that is suitable for your business and your prospective partners. You may choose between the business collaboration agreement template and the Partnership Agreement template services from Zegal. You may also seek assistance from your lawyer or legal division about formulating the contract.
It is crucial for each partner to bear a copy of the partnership agreement in order to carry out your business safely. Minimally, the contract should address the partners involved in the agreement, the full names of the partners, outlines of the responsibilities and conditions, date and signatures of the partners.