Partnerships are a type of business structure similar in many ways to a sole proprietorship but also with some similarities to a small, or closely held, corporation. A partnership is simply a business with at least two owners that has not filed papers to be registered as a corporation or limited liability company (LLC). An equity partnership agreement is a legal agreement between the owners of a partnership that details their rights and obligations as equity holders in the company.
Joint and Several Liability
The two types of partnerships are general partnerships and limited partnerships. In a limited partnership, only the general partner or partners have personal liability for the debts and obligations of the company. This means that if the company goes bankrupt, the general partner is personally responsible for those debts and creditors can pursue the personal assets of that individual.
In a general partnership, all partners have joint and several liability. This means that a creditor or litigant can pursue a legal action against any one of the partners as though that partner were entirely liable, and the partners must then sort out their own level of responsibility among themselves. Whether a partnership will be a limited partnership or a general partnership with joint and several liability should be determined when the partnership is created via an equity partnership agreement.
The equity partnership agreement should specify the amount of equity owned by each of the partners. This does not necessarily have to be directly proportional to the amount of money contributed by each partner. For example, some partners may be expected to put in more actual work running the company than others, and some partners may bring valuable expertise or connections to the business. These types of non-monetary contributions can also be the basis of equity ownership levels.
The equity partnership agreement should also specify the profit sharing method of the company. When it comes to profit sharing, there are two basic systems: lockstep partnerships and eat-what-you-kill partnerships. In a lockstep partnership, new partners get a certain number of points representing their level of equity and profit sharing in the company. Typically, the number of points a partner has will depend on the length of time he has been there.
The other major type of profit sharing arrangement is known as the eat-what-you-kill system. This type of system is common in law firms. Essentially, partners share a certain portion of the firm's profits according to their level of ownership, with the remaining profits being distributed to partners based on who originated the business driving that portion of the profits.