If you’re entering into a new business partnership, you should decide how you’re going to split profits and losses between partners before you start making money. You don’t want to find yourself fighting over debts after the fact. The best way to avoid partnership disputes over profits and losses is by planning their allotment in your partnership agreement.
Without a partnership agreement in place, equal partners assume profits and losses equally. This might work in some cases, but partners with absolutely equal power risk running into a decision-making stalemate that could derail their partnership.
Partnership profits and losses are often distributed based on capital contributions and management responsibility. General partners take on greater personal risks and are often rewarded with greater profits to reflect their precarious position, while limited partners are shielded from liability beyond whatever they’ve invested in the partnership.
Technically, your partnership’s profit and debt-sharing ratios could be whatever arbitrary numbers the partners agree upon – as long as you specify the terms in your partnership agreement. Your arrangement should reflect the investments made and risks taken by each partner in the venture so that nobody feels shortchanged when it comes to profit distributions.
A qualified business attorney can help you weigh all of the relevant factors and come to a profit- and debt-sharing agreement that sets up your partnership for success.
How Can Partnership Profits and Losses Be Distributed?However you decide to divide your profits and losses, you should clearly lay out these terms early on in your partnership, ideally in your partnership agreement. Unless you specify otherwise, the law will generally divide profits and losses equally between equal partners.
Many factors can affect how a partnership splits its profits and losses. The amount each partner gets will depend first on whether they are a general or limited partner.
Examples of Profit and Loss Distribution in PartnershipsYour loss distribution and profit-sharing agreements make up two important parts of your partnership agreement. Ultimately, your partnership agreement should show a full picture of your business arrangement: the number of total partners, the responsibilities and contributions of each partner, and the liabilities each partner takes on.
Some common examples of profit-loss sharing scenarios may look like:
You can also revisit your profit-sharing and loss-sharing agreements as your partnership grows. You can always update these agreements to reflect changes in your business.
The best approach is to come up with a profit and loss distribution model that makes sense to you. It’s best to do this early on in your partnership, ideally with the help of a business attorney who has experience evaluating partnership contributions. Call the Philadelphia area offices of Holmes Business Law now at 215-482-0285 or use our contact form to get started.
Your partnership operating agreement is the most important document when it comes to setting up your business partnership for success. A proper partnership agreement should establish several key operating decisions, such as each partner’s contributions to the venture, their voting rights, percentage of ownership, management duties, and share of profits. But the basics of your partnership operating agreement are just as important – your business name, where your office will be located, the actual purpose of your business. These “basics” of establishing your business partnership are often not that basic after all, which is why you should get a business lawyer involved early on in the process.
To start, picking a name for your business partnership sounds simple enough. But before you settle on a name, you must make sure the brand or trademark isn’t already taken. You must also make sure to include the proper legal name of your business as well as any additional trade names or “fictitious names” such as “doing business as” (DBA) names.
For example, the legal name of your limited liability partnership could be “Company ABC, LLP,” but you may also refer to your business as “The ABC Company” in advertising materials and simply “ABC” in internal documentation. These trade names should all be properly registered and associated with your partnership’s legal name.
Missing these critical details could cost you later on – for example, if you have to change the name of your business after months of building your brand. The best approach is to be as thorough as possible from the start so that the foundations of your partnership start off strong.
Where Should You Register Your Partnership’s Main Office?
As you set up your business partnership, you must decide where your business will be registered (with a registered agent) and where you will have your “principal place of business.” Your headquarters does not have to be the same place your agent is registered.
Your principal place of business is the primary location where your partnership conducts the bulk of its business functions. Usually, this is the place where the partnership keeps its business books and records as well as where the partners or senior management report when they go on-site.
However, this may change depending on the nature of your business. For example, you may have one office for board meetings but another location where the company’s operations are actually coordinated and managed.
Your principal place of business does not have to be a “traditional” office. A dentist’s main office could be the location where they see patients. For an auto mechanic, your principal place of business could be the garage where you repair vehicles.
If your principal place of business is in a different state than where you originally registered your partnership, you will have to register and designate a registered agent in both states.
For example, if you registered your partnership in Delaware but your headquarters operates out of Pennsylvania, you will need a registered agent in both states.
Your partnership’s state of registration and principal place of business will determine how you get taxed, whether you have any additional legal requirements to fulfill, and where your partnership could get sued in the case of a legal dispute. A business lawyer can help you determine the best and most strategic configuration for your partnership.
What Is the Length and Purpose of Your Partnership?
How long do you and your partner plan to be in business together? Are you collaborating on a one-shot or long-term venture? Do you plan to sell your company or take it public?
What products or services will you be selling exactly? How do you plan to conduct your day-to-day business? What metrics will you use to calculate your success?
These are all important questions to consider while you’re forming your partnership. And although the answers may seem basic or even self-explanatory, your partnership benefits from laying out the length and purpose of your venture in clear terms from the beginning.
Stating your partnership’s purpose helps keep you on track towards your goals. Not only that, but the terms of your partnership operating agreement will come into play if there’s ever a partnership dispute. For example, if you sense that your business partner is taking your company in an unsanctioned direction, you could show the terms of your partnership agreement as evidence that their actions do not align with your original goals.
What Types of Partners Make up Your Partnership?
Pennsylvania and New Jersey state laws recognize limited partnerships, limited liability partnerships, and general business partnerships. Each of these partnership structures comes with pros and cons for limited and general partners.
What’s the difference between a limited partner and a general partner?Simply put, general partners have a lot more to gain and lose from your partnership. They tend to get the bulk of the profits while also taking on the greatest risk of liability.
If the partnership fails, general partners would be on the hook (personally liable) for paying off the partnership’s debts. In contrast, limited liability partners are only liable for the amount they’ve invested into the partnership. Creditors can go after a general partner’s personal assets to recover their losses but cannot reach the personal assets of a limited partner.
Because general partners have a greater stake in the partnership, they often get the bulk of the venture’s profits as well as managerial control. Limited partners tend to have limited responsibilities and privileges as well as limited liability. In many cases, limited partners act as “silent partners,” especially if their primary contribution is capital investment, not expertise.
Your status as a general versus limited partner will affect your voting rights, decision-making authority, debt liability, and profit share in the partnership.
How Should You Choose Governing Law for a Partnership?
The laws that govern business partnerships vary by state. States have different requirements and processes for filing partnerships and resolving partnership disputes. You can include a “choice of law” or “governing law” provision in your partnership agreement to specify which state’s laws you wish to apply to your partnership in the event of any legal issues.
Why is a governing law provision so important? This allows you to choose a state with laws that benefit your partnership. Your choice of state law also helps make the dispute process more predictable and manageable for your partnership. You’ll know exactly which laws apply to your venture and you won’t have to deal with an unfamiliar state’s laws.
An experienced business attorney can help you structure your partnership in a way that is best geared for success on your terms. Call the Philadelphia area offices of Holmes Business Law now at 215-482-0285 or use our contact form to get your partnership started on the right foot.
Sarah E. Holmes is a Philadelphia business attorney and strategist that helps start ups and established businesses looking to expand, protect their assets and increase their profits in an approachable, down-to-earth way. When you're looking for a business lawyer in Philadelphia, the Main Line or New Jersey, we can help.
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