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Regardless of the type of entity you are forming, you should always have an operating/partnership agreement.
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The agreement will help dictate the rights and responsibilities of all the partners/members of the entity.
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And when setting up the agreement, its essential to have some specific clauses that govern important parts of the entity.
A few weeks ago in this blog, I wrote about the importance of having written vendor agreements. And I wrote that there is so much important information to include in the agreements that I would have to re-visit the details in a later article. Well guess what? Is today that day? No. No it is not.
But I am writing about a similar topic. Once again I’m going to stress the importance of having a written agreement. But this time, instead of a vendor agreement, it’s the importance of having a written partnership agreement to govern the details of your relationship with your partners.
I don’t currently have any partners at Bukowski Law, but even without any partners, I still have a written operating agreement. Because when setting up a company or partnership*, we always think that that entity is going to last forever along with the good times. But unfortunately, that is not always reality. Things happen and partnerships break up. And when they do, you definitely want to know what everyone’s rights and responsibilities are. So its vital to have a written partnership agreement to spell those out.
Why is a Partnership Agreement Important
I have had lots of conversations with real estate investors about what is required in a partnership agreement and why it is important. Typically the most push back happens when the investor is just investing with one or two other people – especially when they are close friends or family. But this is often when it is most important to have a written partnership agreement.
When a client is investing in real estate, for slight tax benefits, we generally recommend setting up a limited partnership as the single purpose entity (SPE) to own the property. In a typical structure, we often then recommend a limited liability company as the general partner and/or investment entity for our client. And with all of those entities, we of course strongly recommend having an operating agreement.
The partnership/operating agreement is vital because if anything does go wrong, the terms of the agreement will dictate the rights and responsibilities of all of the partners. It will help resolve disputes, divide up the ownership, and hopefully avoid costly litigation. And while there are some rules under Texas statutes, owners generally have the flexibility to dictate the partnership terms when drafting the agreements.
Important Partnership Agreement Clauses
While you can generally include any clauses in a partnership agreement that you want, there are some important categories of clauses that all agreements should contain. Some of those are:
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Rights and powers of the general partner – Its important to dictate what controls the GP has on a daily basis, what it needs approval to do, when the limited partners can step in and remove the GP if necessary, etc.
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Limitations on the limited partners – Limited partners have limited liability precisely because they do not control the day to day activities of the partnership. But that should be spelled out clearly in the partnership agreement – along with any authority they have to vote for special powers, remove the GP, etc.
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Tax issues – Its important to set out the tax implications of the cash flows from the deal. We often consult with a tax accountant on these issues.
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Contribution/ownership – The agreement must contain the contributions from each partner and the resulting ownership of the entity that each partner has.
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Distribution of proceeds – This may be the most important part of the partnership agreement – how does everyone get paid? When the deal is sold, what are the waterfall payments? That should be included in the agreement.
As you can see, the partnership agreement is essential to keeping an orderly and functioning entity. Even with just a couple of partners, its extremely important to have an agreement that dictates the rights and responsibilities of all parties. So if you are putting together an entity and need help with the operating agreement, give us a call and let us help.
*In this article, I’m writing about partnership agreements because that is the usual entity form we use when setting up a single purpose entity for investment purposes. But the same principles work for any other type of entity – LLC, corporation, etc. In these instances, you can just substitute operating agreement or company agreement for partnership agreement.
