Partnership Agreement Vs. Operating Agreement: Key Differences

Starting a business can be very exciting, but it’s important to understand the legal requirements and agreements that come with it.

Entrepreneurs need to be aware of two key documents: the Partnership Agreement and Operating Agreement. While both agreements are essential for defining the structure and operation of a business, they serve different purposes and have distinct differences.

In this blog article, we will journey through the fundamental differences between Partnership Agreement and Operating Agreement and how they can impact your business. Whether you are establishing a new business or looking to restructure an existing one, understanding these documents can help you make informed decisions.

What is a Partnership Agreement?

A partnership agreement is a document that details the relationship between two or more partners in a business. It sets out the terms and conditions of the partnership.

Such as the duties of each partner, how profits and losses are shared, how decisions are made, and how the partnership can be dissolved.

What Is An Operating Agreement?

An operating agreement is a key document negotiated by limited liability company members. It outlines the company’s financial and functional decisions, including rules, regulations, and provisions. The document can vary from just a few pages to dozens of pages.

An operating agreement outlines the LLC’s structure, the members’ roles and responsibilities. It also details the distribution of profits and losses, and how the LLC will be managed.

Having an LLC operating agreement is essential because it helps avoid misunderstandings and conflicts between the members. It also provides a clear framework for decision-making, and ensure that the business complies with state laws.

Can an LLC have a Partnership Agreement?

An LLC cannot technically have a partnership agreement. But the business partners can draft an agreement that defines all the partners’ rights and responsibilities and legally binds them. This document is an operating agreement. 

A partnership agreement is designed for partnerships and may not address all of the unique issues that an LLC may face. For example, a partnership agreement may not address the management structure of an LLC or the allocation of membership interests.

These are important considerations of an LLC operating agreement.

Benefits of An Agreement

An agreement is an official document that summarizes the terms and conditions of a partnership between two or more individuals or entities. It is vital to have an agreement because it establishes the rights, responsibilities, and expectations of each partner. It also helps to prevent misunderstandings and disputes that can arise in the course of the partnership.

Some reasons why you might need a business agreement include the following:

• Clarifying the roles and responsibilities of each partner. An agreement can help define each partner’s specific duties and obligations within the partnership.
• Protecting the interests of each partner. An agreement can include provisions that protect the interests of each partner. Such as outlining how profits will be divided, how decisions will be made, and how disputes will be resolved.
• Establishing the terms of the partnership. An agreement can set out the partnership’s duration, each partner’s contributions, and other important terms that will govern the partnership.
• Meeting legal requirements. In many jurisdictions, partnerships must have a written agreement to be recognized as legal entities.

Contents of a Partnership Agreement

The contents of a partnership agreement can vary depending on the specific needs and goals of the partners but typically include the following:

• Partnership name and purpose. The agreement should clearly state the partnership’s name and its meaning or objectives.
• Contributions and ownership. The agreement should outline the amount of capital or assets each partner contributes to the partnership. And the percentage of ownership each partner will have.
• Distribution of profits and losses. The agreement should specify how profits and losses will be divided among the partners. This can be based on the percentage of ownership or some other agreed-upon formula.
• Decision-making and management. The agreement should outline how decisions will be made within the partnership. And who will be responsible for organizing the business’s day-to-day operations.
• Capital accounts and withdrawals: The agreement should detail the method of capital accounts maintenance and how partners can withdraw funds from the partnership.
• Dispute resolution: The agreement should include a process for resolving disputes between partners, such as mediation or arbitration.
• Dissolution and termination: The agreement should outline the conditions under which the dissolution of the partnership can occur and the process for doing so.
• Non-compete and confidentiality agreements: The agreement may include provisions prohibiting partners from competing with the partnership or disclosing confidential information.
• Succession and exit strategy. The agreement should outline what happens if a partner wishes to leave the partnership and the process for adding new partners.

It is necessary to consult a lawyer when drafting a partnership agreement to ensure that it is legally binding. And covers all essential aspects of the partnership.

Contents of an LLC Operating Agreement

The LLC operating agreement should address the following key areas:

• Formation. The partnership structure should be clearly defined, in this case, a limited liability company. 
• Name and Purpose of the company. The document should specify the name of the company and the purpose of the LLC. Such as the type of business it will operate, the services it will offer, or the products it will sell.
• Members. It should identify the members of the LLC and their ownership percentage.
• Management. It should define the management of the LLC, including the decision-making processes and who has the authority to make them.
• Capital Contributions. It should set out the capital contributions of each member, including how much each member has invested in the business.
• Profits and Losses. It should explain how the profits and losses incurred by the LLC will be shared among the members.
• Distributions. It should specify how the LLC will distribute profits to its members, including how often distributions will be made.
• Dissolution. It should outline the process for dissolving the LLC, including how assets will be distributed and how debts will be paid.
• Voting Rights. It should detail the voting rights of each member, including how votes will be cast and how many votes each member is entitled to.
• Transfer of Ownership. It should set out the conditions under which members can transfer ownership of their interest in the LLC.

Differences between Partnership Agreement and Operating Agreement

A partnership agreement and an operating agreement are legal documents that establish the rules and procedures that govern the operation of a business. However, they differ in their scope and purpose. Here are the key differences between a partnership agreement and an operating agreement:

1. Legal entity

A partnership agreement is used to establish a partnership, while an operating agreement is used to set up a limited liability company (LLC).

2. Ownership and management

A partnership agreement defines the ownership structure and the roles and responsibilities of the partners. An operating agreement establishes the ownership structure, but also outlines the management structure. It also details the roles and responsibilities of the members and managers of the LLC.

3. Liability protection

A partnership agreement does not provide liability protection for the partners. While an operating agreement provides limited liability protection for the members of the LLC.

4. Taxation

A partnership is taxed as a pass-through entity, where the income is reported on the individual partners’ tax returns. An LLC can also be levied as a pass-through entity, but it can also elect to be taxed as a corporation.

5. Formality

Partnership agreements are generally less formal than operating agreements. A partnership agreement can be verbal or written, while all members must sign an operating agreement in writing.

Conclusion

Understanding the primary differences between Partnership Agreement and Operating Agreement is crucial for any entrepreneur looking to start or restructure a business.

While both agreements define the structure and operation of a company, they have distinct differences in scope, purpose, and legal implications. By carefully considering these differences and consulting with legal professionals, entrepreneurs can create agreements that protect their interests. They can also minimize risks, and facilitate smooth and efficient business operations.

Whether forming a partnership or starting an LLC, taking the time to understand and create these agreements can be the key to long-term success.