Texas recognizes several forms of partnerships. Specifically, there are General Partnerships, Limited Partnerships, and Limited Liability Partnerships. Each has advantages and disadvantages and are explained more fully here. However, they all have one thing in common – they all have more than one owner. As a result, they should ALL have a solid partnership agreement.
Partnership agreements are contracts between the partners which controls how the partnership is managed, how profits and losses are distributed, and how partnership interests are acquired or transferred. While each partnership endeavor is different, there are some common essential elements any partnerships agreement should include.
Division of Profits and Losses
When creating a partnership, the perspective owners have a great amount of flexibility when it comes to the amount of ownership for each partner and how the profits and losses of the partnership are distributed. For example, the initial partners could each contribute a specific amount of cash in exchange for a proportionate amount of ownership and share of profits. Or, one partner could contribute cash and the other partner could contribute time and effort. In this scenario, the cash-contributing partner may have a larger percentage of ownership, but the “sweat equity” owner may have a larger percentage of future distributions of profit and loss.
Another issue owners should consider are the timing and amounts of payments to partners. There are a number of tax issues related to payments made to partners. Specifically, partners are not paid salaries in the traditional sense. The IRS considers payments made to partners on a routine basis as “guaranteed payments.” These guaranteed payments are subject to self-employment taxes. Partners should consult with a CPA or other accounting professional familiar with taxes in a partnership.
Making decisions in a business is often like trying to make decisions in a committee- nothing gets done. In fact, it can often come to a company stalemate a company and result in business failure. Therefore, you need to establish a decision-making process in advance so your business operations can move along smoothly.
In addition, unless provisions are made within the partnership agreement, any partner can bind the partnership without consent from the others partners. That means a partnership can be held financially responsible for any purchase an individual partner decides to make. Imagine if a partner decides to buy a “company car” from a sporty little Italian automaker named Ferrari. Such a huge expense could bankrupt a small firm. As a result, it is important to specify exactly what transactions partners can make that will bind the partnership.
Withdrawal of a Partner
There are a number of circumstances under which a partner may want to withdraw from a partnership. Personal reasons may force a partner to move away. A career change may warrant withdrawal. The ownership of a partnership is considered a personal property right. As a result, the withdrawing partner can transfer his ownership to anyone or any entity unless provisions in the partnership agreement control otherwise.
Usually provisions are written where the remaining partners are given the right of first refusal on any potential sale of ownership interest. This means the partners are able to rebuy the interest for sale on whatever terms the selling partner has secured from the third party buyer. If the remaining partners fail to purchase the interest, the selling partner is normally free to sell.
Additionally, there are certain “triggering events” which may force the sale of a partnership interest. For example, the death of a partner may trigger the sale of the interest. A good partnerships should anticipate these triggering events and how the partnership interest will be valued in order to complete the sale. Other potential triggering events could include the divorce of a partner (especially in community property states like Texas), the conviction of a felony, disability of a partner, or commission of fraud against the partnership.
There are a number of other provisions which should be included in a good partnership agreement. However, the three sections above are absolutely essential for good management of the company. For help in setting up your partnership, please contact us here.