You don’t have to create a partnership agreement by law in order to run a small business with a friend or a family member. But you should create one anyway.
A partnership agreement can help you set your company up for success by addressing key issues, like what should happen to the funds in your business bank account and who will be responsible for which tasks.
Not sure where to start with your partnership agreement? Here are four clauses that absolutely need to be included.
1. Details about partner duties
Your partnership agreement should include details about the role you will each play in the company. While you don’t have to assign every single job, it should be clear who will have authority to handle some of the major aspects of your business operations.
Providing a description of partner duties can help you ensure you are both on the same page about the level of responsibility you are each taking on. It can also ensure you don’t both want to be in charge of the same aspects of your operation, which could lead to conflict.
2. Distribution of profits and losses
Ideally, you and your partner will begin making a profit soon after starting your business. If you do, you’ll need to be clear on how the money will be divided up between you. You don’t want there to be conflict about how the money ends up being distributed.
If the company doesn’t make a profit right away, you’ll need insight into who will cover the cash shortfalls and who will declare the losses on their tax returns in order to lower their taxable income. You cannot both claim the same business losses, and you don’t want a fight over who gets this tax break when tax-filing season comes along.
3. A death and disability clause
It may be difficult to think about, but one of you could die or become disabled and unable to run the business. In that situation, things can become complicated. You’ll need to address what will happen.
For example, will the surviving business partners buy out the interest of the deceased owner and continue to run the company themselves? Or can the deceased person leave their interest in the company to a family member? If so, will that family member then become a part of actively managing the business and claiming profits and losses? Will that arrangement work for the other surviving business owners who could find themselves working with a new person?
This issue must be addressed. And if the other business partners need to buy out someone who dies, will there be enough money? In some cases, it makes sense for life insurance to be purchased on each partner that could be used to buy out the interest of one who passes. This way, their surviving family members get a payout and the company can maintain operations.
4. A dispute resolution process
Finally, it’s important to have a plan outlined in the partnership agreement for how conflicts will be addressed so you don’t find yourself in a stalemate if you disagree. If you can’t resolve a disagreement, it could be disastrous to your business operations.
By addressing these issues, you can avoid major problems down the line and maximize your chances the company will be a success for both you and your business partner.