Partnership formation examples: eight scenarios

These partnership formation examples are eight invented arrangements between people who went into business together. None is real. Each turns on a term that was either agreed in writing or left to the state's default rules, and in every case the term only became visible when something changed.

In the United States, partnership rules come from the applicable state's law, often based on the Uniform Partnership Act (UPA) or Revised Uniform Partnership Act (RUPA). These are model acts, not nationwide laws: the version a state has enacted, along with other applicable state law, determines the actual defaults. The examples show why founders should address key terms in a written partnership agreement before they start.

The pattern worth noticing: none of these problems is about the work. They are all about what happens when the work stops being shared equally.

What to take away

Money and work are not the same contribution

One puts in the money, the other puts in the hours. Two people open a small workshop. One funds the equipment, the other works full time while the funder keeps a job. Nothing is written about how the funding is treated: is it capital, a loan, or bought equity? The written partnership agreement should say how the contribution is treated and address repayment, ownership, and profit and loss allocations. If the partners leave a term open, the applicable state's default rules may matter. Eighteen months in, the workshop is profitable and both have a completely different memory of the answer.

The customer list as a contribution. One partner brings an existing client base and the other brings capital. The written partnership agreement can state whether client records, goodwill, or other property are contributed to the partnership or remain with the contributing partner, and what happens to them if the partners separate. A client list alone does not settle those questions; the agreement, applicable state law, and any relevant client contracts may matter.

The split that drifts

Equal shares, unequal effort. A fifty-fifty arrangement where, by year two, one person is working four days a week and the other one. No mechanism exists to change the split, because nobody imagined it would need to. Each is now behaving in a way the other reads as bad faith. Under RUPA's default rules, partners generally have equal rights in management and equal shares of profits, but the applicable state's enacted law and the partnership agreement control. The agreement can address whether effort affects compensation, profit allocations, or decision-making.

Drawings without a rule. Both take money out as needed. There is no schedule, no cap and no record of who took what. At year end the figures do not match anybody's memory, and there is no document to appeal to. For federal tax reporting, partnerships generally file Form 1065 and provide each partner a Schedule K-1 reporting that partner's share. Drawings do not by themselves establish the partnership's profit allocation. The IRS's Instructions for Form 1065 are a starting point for the reporting side; an accountant can advise on the partners' records and tax treatment.

The exits nobody wrote down

A partner dies. With nothing agreed, a partner's death may trigger dissociation, a buyout, dissolution, or continuation, depending on the applicable state's statute and the partnership agreement. An estate may have economic rights without automatically taking over the deceased partner's role in running the business. An agreement can address what happens and how the partners will handle a buyout or continuation.

A partner wants out and there is no price. No valuation method, no timetable, no obligation to buy. The applicable state law may supply some rules, but the result can still be a costly dispute or a business that cannot function as planned. A partnership agreement can set the process, timing, and valuation method in advance.

A partner does something the others did not authorize. In many default arrangements one partner can bind the business. Whether that happened here, and what follows from it, is a question for a lawyer with the state's own rules in hand. What is certain is that the possibility existed and nobody had checked.

The arrangement that was never intended

Two friends who never decided. They shared work and money for two years, called it nothing, and filed nothing. Under state partnership statutes, people carrying on a business as co-owners for profit may form a general partnership through their conduct, even without filing a formation document; the exact rules and exceptions depend on the state. They may therefore be subject to partnership defaults without realizing it. The general reasoning is in forming a partnership with two owners, and the alternative forms they never considered are compared in choosing a business structure.

What would have prevented seven of the eight

A written partnership agreement covering contributions, ownership, profit split, decision rights, drawings, valuation and exit. It is a few hours of work with a lawyer, and its real value is that it forces the conversation while everyone still wants the same outcome.

A partnership generally needs an Employer Identification Number (EIN) from the IRS for federal tax administration. The IRS accepts an application using Form SS-4 and issues an EIN at no charge. See the guide to applying for an EIN.

If the business trades under a name that is not the partners' own names, it may need a DBA (doing business as), assumed-name, or fictitious-name filing. The name and filing requirements, including which state or local office handles them, vary by location; see DBA and assumed-name registration. A name filing does not form an LLC or replace the partnership agreement.

If it has already been years

Write it now. Be explicit about which parts are recording what you both already believe and which parts are new terms being agreed today. That distinction prevents the exercise from turning into a renegotiation of the past, which is what usually derails it.

Then keep the records current. Ownership changes, address changes and new partners may require updates to applicable records; the general list of what to review after an event is in keeping business records current. The SBA's overview of registering a business is a fair map of which registrations exist at all.

Common questions

Are these real partnerships?

No. Every one is invented, including the trades and the outcomes. They are shaped like the disputes that get described in general terms, and no real person or business is described.

Which is the most damaging?

The death of a partner with nothing agreed, because it introduces a party who never chose the business and cannot be negotiated with on the usual terms.

Would forming an entity have prevented these?

Forming an LLC would change the legal structure and generally limit its members' personal liability for business obligations, subject to exceptions. It would not by itself decide contributions, profit allocations, decision rights, or exits; an LLC operating agreement can address those terms, and state law supplies applicable defaults. The same eight questions in the partnership formation examples should be considered when choosing a structure.

We get on well. Do we really need this?

Getting on well is the condition that makes the agreement possible. It is not the condition that makes it unnecessary. Every one of the eight above began between people who got on well.

What is the first clause to write?

The exit. If you can agree how someone leaves and at what price, the rest of the document tends to write itself.