A partnership can be created on a handshake, as long as at least two parties verbally agree to do business together and share profits and losses. Without a written partnership agreement, however, disputes may arise regarding ownership interests, voting rights, management, buyout procedures and even the dispute resolution process itself.
Contributions and Allocations
Ownership interests are normally determined by capital contributions -- a partner contributing 30 percent of the partnership's capital, for example, has a 30 percent ownership interest and is entitled to 30 percent of its profits. Depending on state law, however, a partnership may decide to distribute the right to receive profits in a proportion different from capital contributions. It may, for example, grant a partner contributing 30 percent of the partnership's capital the right to 40 percent of its profits, in recognition of unique expertise that the partner may bring to the partnership. Accordingly, the partnership agreement should list both capital contributions and profit-sharing percentages.
A partnership agreement should specify the authority to participate in partnership decisions in line with each partner's ownership interest. The authority to participate in partnership decisions affects the economic value of that interest, and is likely to influence partnership profits. The partnership may or may not choose to distribute voting rights in proportion to ownership interests. Some partnerships grant each partner an equal right to participate in day-to-day management, while others endow particular partners with this authority. Still other partnerships hire non-partner employees to manage the partnership.
Changes in Membership
Changes in membership may affect the profit split among the partners -- the profit-sharing interest of a withdrawing partner, for example, must be split proportionately among the remaining partners unless the withdrawing partner sells his interest to an outside party. Many partnership agreements require withdrawing partners to sell their shares to the partnership, while others allow withdrawing partners to sell to an outside party if he offers the same sale terms to each current partner and is refused. Some agreements require unanimous consent to the addition of a new partner.
A partnership agreement should designate a dispute resolution method in advance. If a dispute arises and the partners cannot agree on the forum for resolution, it might be litigated for years, draining partnership resources and encouraging partners to withdraw. Arbitration is a popular method of dispute resolution because it is usually quicker and cheaper than courtroom litigation. Arbitration awards, however, generally cannot be appealed to a court without evidence of corruption in the arbitration process.