How Does a Partnership Agreement Work?

A Number of Individuals

A partnership agreement is usually discussed when two or more individuals start up a business. It is a contract between the parties who are contemplating the joint business venture, and their signatures signify that they understand the terms of the partnership and are willing to be legally bound by all the rules they have devised.

Defines the Parties to the Contract and Time Limitations

One of the most important aspects of a partnership agreement is the clear definition of the individuals who are party to the contract. This eliminates any problems with respect to married couples where one person may be involved in a business and the other is not. Additionally, the time limitations protect partners who are only entering into the agreement to provide seed money and who expect to receive a certain percentage of the profits in addition to repayment, but who want to remain free and clear from any loan obligations the new business may take on.

Scope of the Business and Fiscal Contributions of all Parties are Listed

The participants in the partnership agreement define the scope of the business venture and put into print how much money each partner contributed or has pledged to contribute. This is a vital step that secures the seed money for the business and contractually binds individual partners to their agreed upon payment. Since the business activity is limited, this clause also protects the business itself in that it will not deviate from its original intent, thereby jeopardizing the partners' investments.

Defines the Partners' Salaries

Although each partner most likely understands that initially their salaries will be limited, the partnership agreement defines which percentage of the profits each partner is entitled to claim as a salary. Some contracts include a clause the limits partners' eligibility for additional bonuses, if certain business benchmarks are not met.

Protect Individual Partners from Liability

For the partners, and for those who decide to enter into business with them, one of the most important tasks the partnership agreement performs is the distribution of liability. It defines whether a business is a general or limited partnership, which leaves all partners liable for all business debts, or a limited liability partnership, which protects individual partners from the debts of other partners.