A Handshake Isn't Good Enough for a Partnership Agreement
Legally, you can still create a general partnership agreement with a handshake - but it's not smart. Like any relationship, partnerships are fraught with opportunities for disgreement and misunderstanding. But unlike most relationships, once you enter a partnership agreement with someone, you're legally yoked to them until the partnership is officially dissolved.
Using a written partnership agreement to formalize your partnership arrangement saves personal grief down the road because it allows you and your partner(s) to agree on how you're going to handle particular situations before they arise. It will make the day-to-day operation of your partnership smoother and prevent problems from escalating into full-blown crises.
And don't dismiss the necessity for a partnership agreement because your proposed partner is your good friend; some of the ugliest partnership breakups I have heard about or witnessed have occurred between friends who assumed that they knew what their friend thought or would do.
Elements of Good Partnership Agreements
A good partnership agreement has to provide answers to these questions:
1) What is the financial contribution of each partner?
Memory is fluid and unreliable. You want to ensure that the financial contribution that each partner brings to the partnership is written down in your partnership agreement in case of later disagreement.
2) What is the division of work between the partners?
It's critical to get this sorted out before you start operating as a partnership, because this is the most common way that partners step on each other's toes. What will each partner actually do? How will they do it day to day? Who's responsible for what decisions?
3) What constitutes income in the partnership?
Obviously you hope that your partnership makes a profit. But how will partners draw income from those profits? If it's agreed that partners will draw salaries, how much and how often? What percentage of the profits will be plowed back into the business?
4) What property is included in the partnership and how is it defined?
Partners often bring property to the partnership that is less tangible that a piece of land or a building. Client lists, computer applications, goodwill, process designs - whatever intellectual or personal property that a individual brings to a partnership needs to be itemized and described in your partnership agreement. And if a partner is bringing tangible property to the partnership, get that written down and described, too.
5) How will/can partnership property be used by individual partners?
Sometimes property use is obvious. If two people decide to partner to open a restaurant and one partner brings a property that she owns with a building suitable to being a restaurant on it to the partnership, that's presumably what they would do. But sometimes it's not. Does the creator of the web application want to allow the other partner(s) to modify it? Will the hairdresser share her clients? Get it sorted out ahead of time to avoid a lot of thorns.
6) How will bank accounts be set up and how will accounting and tax matters be handled?
Obviously your partnership will need a business acount. But how will signing privileges be set up? Will your business use a line of credit? Can purchases be made without the consent of other partners? Will your partnership use a bookkeeper and/or accountant or will one of the partners do this?
7) How will disputes related to the partnership be resolved?
It's very nice to say that "we'll sit down and discuss whatever issue comes up". And you and your partner(s) may well do that. But that doesn't mean that you'll agree. Turning over your dispute to a mediator agreed on in advance is one way to break deadblocks. Another is to use your business advisory board to resolve disputes. Whatever way you choose, make sure that you have it written into your partnership agreement.
8) What happens if one partner dies or becomes disabled or incapacitated?
If one partner becomes incapacitated or dies, how will the other(s) carry on the business? Making arrangements ahead of time can mean the difference between being able to continue doing business and business collapse. A buyout agreement is the answer; it specifies what happens to the ownership of the business if something happens to one of the partners. A buyout agreement can be an entirely separate agreement or exist as several clauses in your partnership agreement.
9) What happens if one partner wants to leave the partnership?
This is also a situation that will be covered by your buyout agreement. Issues your buyout agreement should cover include whether or not a departing partner has to be bought out, what price will be paid and how, and who can buy the departing partner’s share of the business. (This may be limited to other partners, for instance.)
10) How will sale of the business be handled?
Any small business should have its exit strategy planned from the get-go but it's even more important with a partnership.If selling the business is the plan, partners need to agree in advance on acceptable processes and numbers. Two prime areas of future disagreement; business valuation and profit sharing. Commonly one partner feels she put more into the partnership or worked harder, so is due a bigger share.
Partnership Agreements Are Essential
Planning ahead avoids disputes and costly court battles later. No matter how much of a friend your potential partner is, you should never enter a business partnership with him or her without a formally drawn up partnership agreement.
Also, as partnership is a complex issue, I always recommend that people have partnership agreements drawn up by lawyers or other legal professionals who can explain partnership issues in more detail and make sure the partnership agreement says exactly what it needs to say.