How to structure partnership agreements

Introduction

A partnership is essentially a business arrangement whereby people with common business interests come together to form a partnership to carry on business for mutual benefit.

Unlike a company which is registered as such and has shareholders and directors a partnership has partners who in most cases are full time in the business.

Partnership are quite common with professional service providers such as legal practitioners, chartered accountants, health professionals such as doctors and many others.

Key aspects in a partnership agreement

It is advisable for partners to document their agreement especially at the formative stage to avoid differences or disputes later on. Key aspects to include the following: ◆ Capital contributions

◆ Sharing of profits and losses ◆ Management structure, duties and roles

of partners

◆ Acceptance of liability

◆ Decision making process

◆ Financial management systems

◆ Risk management system

◆ Admitting a new partner

◆ Dispute resolution

◆ Termination of a partnership

Capital contribution

Usually when partners form a partnership they estimate funding requirements for the business to cover working capital and any capital expenditure requirements during the formative stages and they agree what each partner should contribute.

Capital can be contributed in cash or kind, at once or spread. For example partners can agree that each partner contributes so much per month towards expenses until revenue is adequate to cover the business expenses.

Sharing of profits and losses

This aspect makes or breaks partnerships. It is advisable that partners agree on these ratios upfront or make provision for their revision.

It is quite common for partners to go separate ways if one feels he/she is getting less than what he/she deserves or that another partner is benefiting unfairly from a higher profit share compared to his/her contributions to the financial performance of the partnership.

Several safeguards can be put in place to address such possible situations as explained below. Partners should be as realistic as possible when setting profit and loss sharing ratios.

There is no one method or way of determining this ratio.

Many factors are considered such as whose ideas it is, if one partner is being invited into the partnership, capital contributions, skills and expertise, potential client base, networks, financial needs, etc.

There should be a reasonable and acceptable way of arriving at this ratio.

A partnership agreement should also provide for altering the profit and loss sharing arrangement should circumstances change.

It is quite common for partners to set targets for each other so that no partner relaxes and benefits unfairly from the hard work of the other.

Partners who do not meet targets may be asked to leave the partnership or have their profit sharing ratio reduced.

Partners may also agree to pay each other salaries. Setting different salary scales may address the different contributions in effort, time or financial performance of the partnership.

It is also possible for partners to pay each other commissions or performance bonuses based on for example income earned. This will benefit the performing partners and disadvantage the less performing ones.

Another possible arrangement is whereby partners agree to share expenses instead of profits.

They agree ratios on their contributions to cover partnership expenses such as rent, staff salaries, licence renewals, transport costs, etc.

Each partner retains income he/she earns from the partnership business. The advantage is that each partner’s earnings are consistent with what he she is able to generate.

For example there will not be need for firm wide targets or monitoring the performance of other partners. If a partner attends a funeral for a week or longer or comes to the office later or leaves early that will affect his / her earnings.

The downside being that partners may not benefit from each as their meeting point is expense sharing. Partners may pursue individual instead of firm interests.

Partners may however, share revenue on joint assignments.

Management structure and duties of partners

There has to a management structure. Duties and roles of partners should be specified. It is quite common to find a management structure which has provisions for a Managing Partner, Staff partner, lead partner, senior partner or even partners being responsible for certain categories or clients or certain sectors of the economy.

This brings about order and allows for specialisation.

Acceptance of liability

A partnership agreement should provide for when partners are liable for the actions of their fellow partners, for example on contracts or misconduct such as abuse of trust funds.

Decision making

A partnership should documents its decision making processes so that no partner feels left out. Provision should made for emergencies.

Financial management systems

Partners should agree on financial management aspects such as adequate working capital, capital expenditure, drawings by partners, salaries, payment of profit share, borrowings from financial institutions, investments, protection of trust funds, etc.

Risk management systems

A partnership should have risk management systems. Such risks include legal or regulatory, economic, technological, viability, financial, human resources, disagreements, continuity, etc.

Admitting a new partner

A partnership agreement should provide for the admission of a new partner including conditions thereto.

Dispute resolution

Differences or even disputes are inevitable in business. At times they are a result of due diligence not properly carried out on another eg compatibility or culture.

Dispute resolution should be provided for to save the partnership.

Termination

A partnership agreement should provide for circumstances leading to termination and termination modalities thereof.

Disclaimer

This simplified article is for general information purposes only and does not constitute the writer’s professional advice.

◆ Godknows Hofisi, LLB(UNISA), B.Acc(UZ), CA(Z), MBA(EBS,UK) is a legal practitioner / conveyancer, chartered accountant, corporate rescue practitioner, and consultant in deal structuring and is an experienced director of companies. He writes in his personal capacity. He can be contacted on +263 772 246 900 or gohofisi@gmail.com