Starting a Business With a Partner? Why a Written Agreement Matters

Starting a business with someone you trust can be an exciting step. You may have a shared business idea, complementary skills or a common goal of building something profitable. In the early stages, it is easy to focus on getting the business running and assume that you will work out the details as you go.

However, disagreements can arise when partners have different expectations about money, responsibilities, decision-making or the future of the business.

A written partnership agreement helps establish clear expectations from the beginning. In South Africa, a partnership can generally be formed through a verbal agreement or conduct that demonstrates an intention to establish a partnership. A written agreement is not always legally required, but it provides an important record of the arrangement between the parties.

What is a partnership agreement?

A partnership agreement is a contract that sets out how two or more people will operate a business together. It records the partners’ contributions, responsibilities, financial arrangements and procedures for handling important decisions.

For example, two people may decide to open a catering business. One partner contributes the start-up capital, while the other manages daily operations and customer relationships. Without a clear agreement, they may later disagree about whether their contributions entitle them to equal profits, whether either partner should receive a salary or who has authority to make financial decisions.

A written agreement can address these issues before they become disputes.

It is also important to distinguish between an ordinary partnership and a company. If the business operates through a registered company, the founders may need a shareholders’ agreement and appropriate company documents, rather than relying only on an ordinary partnership agreement. The applicable arrangements depend on the business structure.

Why should business partners have a written agreement?

1. It clarifies each partner’s contribution

Partners may contribute different things to a business. One may provide money, another may contribute equipment, and another may provide professional skills or manage daily operations.

A written agreement should record what each partner is contributing, when the contribution must be made and how additional funding will be handled if the business needs more capital.

This reduces the risk of one partner believing they have contributed more than the other without a shared understanding of how those contributions affect their rights.

2. It establishes how profits and losses will be shared

Making money is often a central goal when people start a business together. However, partners may not automatically have the same expectations about how profits should be divided.

The agreement should specify the profit-sharing arrangement, how losses will be dealt with, when profits may be distributed and whether partners can withdraw money for personal use.

For instance, partners may agree to divide profits equally, or they may choose another arrangement that reflects their agreed contributions and responsibilities. The terms should be clearly recorded rather than assumed.

3. It defines roles and responsibilities

Unclear responsibilities can lead to frustration, especially when both partners believe they have authority over the same decisions or each expects the other to complete a task.

A written agreement can identify who manages finances, oversees employees, handles suppliers, markets the business and makes operational decisions.

It can also specify which decisions require the approval of both partners, such as taking out a substantial loan, entering into a major contract or purchasing expensive equipment.

Clear responsibilities help partners understand their obligations and reduce unnecessary conflict.

4. It addresses disagreements and deadlocks

Business partners will not always agree. Differences may arise over spending, expansion, staffing or the direction of the business.

A partnership agreement can establish a process for resolving disagreements. This might involve an internal discussion, mediation or another agreed dispute-resolution procedure.

For example, if two partners disagree about whether to expand into another province, the agreement can set out how the decision will be considered and what happens if they cannot reach consensus.

Without an agreed process, a disagreement can delay operations, damage the business relationship and potentially lead to legal proceedings.

5. It explains what happens when a partner wants to leave

A partner may eventually want to leave the business, retire, pursue another opportunity or sell their interest. A partner may also die or become unable to continue participating.

The agreement should address how a partner can exit, how their interest will be valued, whether the remaining partner has an opportunity to buy that interest and how outstanding financial obligations will be handled.

It should also explain whether the business can continue and how its assets, liabilities and existing commitments will be dealt with.

Planning for these possibilities does not mean expecting the partnership to fail. It helps the business prepare for changes that may occur over time.

6. It reduces uncertainty about liability

An ordinary partnership in South Africa is generally not a separate legal person in the same way as a registered company. Partners may therefore face personal exposure to business debts and obligations, depending on the circumstances and applicable law.

A written agreement can clarify the partners’ responsibilities between themselves, including how expenses, debts and losses are to be managed. However, it does not automatically prevent creditors or other third parties from pursuing a partner where the law permits them to do so.

Anyone considering a partnership should understand the potential financial risks before committing personal funds or assets.

What should a written partnership agreement include?

Although each business has different needs, a partnership agreement should generally address the following:

* Names and details of the partners: Identify the parties entering into the agreement.

* Business purpose: Describe the business activities and the objectives of the partnership.

* Contributions: Record the money, assets, skills or services each partner will provide.

* Profit and loss arrangements: Explain how profits, losses and withdrawals will be handled.

* Roles and decision-making: Define responsibilities, authority and approval requirements.

* Financial management: Set out banking, accounting, record-keeping and spending procedures.

* Dispute resolution: Establish a process for addressing disagreements.

* Confidentiality and business information: Clarify how confidential information and business records must be handled.

* Exit and dissolution: Explain how a partner may leave and how the partnership may be brought to an end.

* Amendments: Specify how changes to the agreement must be approved and recorded.

The agreement should reflect the actual arrangement between the partners and comply with applicable law. A generic template may not address the particular risks facing the business.

What happens if partners operate without a written agreement?

If partners do not have a written agreement, the terms of their arrangement may have to be established through verbal discussions, correspondence, financial records and their conduct.

A court may need to consider this evidence to determine whether a partnership existed and what the parties agreed to. In Pezzutto v Dreyer and Others, the Supreme Court of Appeal explained that the existence of a partnership depends on the agreement and its essential elements, assessed in light of the circumstances.

Consider a situation in which two friends start an online clothing business. One pays for stock while the other manages social media and customer orders. They begin sharing revenue but never agree on how profits should be calculated or what happens if one wants to leave.

If the business becomes successful and they later disagree about ownership or profit distribution, the absence of clear records may make the dispute more difficult to resolve.

A written agreement cannot guarantee that disagreements will never occur, but it can provide a clearer basis for dealing with them.

When should partners sign the agreement?

Ideally, the agreement should be prepared and signed before the partners begin significant business operations, commit substantial funds or enter into major contracts.

Discussing the terms early gives everyone an opportunity to raise concerns and establish realistic expectations. It is generally easier to negotiate responsibilities and financial arrangements before a disagreement develops.

If the business is already operating, the partners can still seek legal assistance to document their existing arrangement. They should ensure that the written agreement accurately reflects what they have agreed to and that all necessary parties approve it.

Conclusion

Starting a business with a partner requires more than a good idea and mutual trust. It also requires a shared understanding of how the business will operate, how money will be managed and how difficult decisions will be handled.

A written partnership agreement helps establish these expectations and provides a reference point when disagreements arise. It can protect the business relationship by addressing important issues before they become costly disputes.

Before entering into a business partnership, consider obtaining legal advice to ensure that the agreement reflects your intentions, addresses the risks and is appropriate for your business structure.

Planning to start a business with a partner? Ndou Attorneys can assist with understanding your contractual obligations and the importance of putting appropriate business agreements in place.