How to Prepare a Partnership Agreement Within Your LLC

Starting a multi-member LLC opens doors to shared resources, diverse expertise, and potential growth. However, even the most promising business ventures can face serious challenges without established rules for its partners.

An LLC partnership agreement governs the relationships within an LLC. It sets clear expectations and procedures that protect everyone who’s involved in the business. And, more importantly, a well-drafted partnership agreement helps prevent misunderstandings and disputes.

Below, we discuss how to prepare this written document for your LLC.

Key Takeaways

• An LLC partnership agreement covers several aspects of the venture’s operations, including member roles and decision-making processes.
• The document includes other important details such as the LLC’s basic information and management structure.
• If you form an LLC with multiple partners in Nevada, its partnership agreement should be governed by the state’s Revised Statutes for LLCs.
• Partnership agreements apply to an LLC’s multiple members and the relationships between them. Operating agreements include clauses about the company’s operations and each member’s rights and obligations.

Understanding the Purpose of an LLC Partnership Agreement

With an LLC partnership agreement, you and your partners establish how an LLC should operate and manage its finances. Specifically, this written agreement:

Defines Ownership Percentages & Member Roles

LLC partnership agreements set each member’s stake in the business and define their roles within the partnership. Clearly outlining both prevents confusion and encourages all members to be accountable when participating in your operations.

Ownership percentages can be based on the agreed-upon value of a member’s capital contribution. And when it comes to responsibilities, your LLC’s agreement should state whether members would serve as:

• Active managers
• Passive investors
• Employees focused on different aspects of the company’s operations

Also, include details about individual commitments, specific duties, and expectations for each member’s work. You can even group members into different categories if they contribute varying amounts of expertise or time. This structure allows for flexible compensation and voting arrangements that reflect each member’s actual contribution to the business.

Finally, consider adding a non-compete clause. It prevents members from competing with the LLC or working for its competitors.

Specify Capital Contributions

LLC partnership agreements also document all initial capital contributions and govern future ones.

As you draft your agreement, list the type of assets added to the company’s resources and specify procedures for additional contributions. For the latter, clauses about whether members are required to provide more funds and what would happen if they’re non-compliant should be included.

Here are the most common types of capital contributions to LLCs and how they’re valued.

Tackles Membership Changes

Having an LLC partnership agreement is also important because it dictates how your business will manage member exits and additions. Your agreement should cover the following areas:

Voluntary & Involuntary Departures

Over time, your LLC may lose members due to:

• Retirement
• Career changes
• Breaches of duty
• Criminal activity
• Conflicts with other members
• Death

For smooth exits and transitions, your partnership agreement should require LLC members to notify the business of their departure in advance. This clause gives you time to plan for transitions and find new members.

Also, consider outlining procedures for involuntary removals that ensure due process while protecting the business from disruptive members.

Valuations & Payment Terms

Your LLC partnership agreement should specify valuations and payment terms for departing members’ ownership interests as well.

Start by stating how a member’s stake in the business will be valued and whether it needs to be conducted by professional appraisers. Then, establish payment terms that meet the departing member’s needs and determine how much of the LLC’s cash flow will go to the individual. Some partnership agreements allow installment payments over several years, reducing an LLC’s financial burden while ensuring departing members receive fair compensation.

If you want to prevent potential problems caused by member exits, the NCH blog has shared how to structure your business for an easy exit or sale.

Outlines the LLC’s Decision-Making Process

Your LLC also needs a partnership agreement for smooth decision-making. The document outlines how the business will decide on potential changes to its operations. This includes voting thresholds for different types of decisions.

• Simple majority votes are needed for routine business decisions.
• Supermajority votes apply to decisions such as approving major financial obligations.
• Unanimous consent is required for decisions that affect LLCs and its members in the long run.

If a deadlock occurs during the voting process, your partnership agreement should state how this will be handled. Potential solutions include appointing a neutral third-party.

Establishes Profit & Loss Distribution Methods

Finally, an LLC partnership agreement specifies the profit and loss distribution methods that the business will use. They can be determined by ownership percentages or other chosen formulas.

Distribution Formulas & Timing

Your LLC’s agreement must include clear formulas for distributing profits and allocating losses among members. While many LLCs distribute profits based on ownership percentages, you might choose and use different allocation methods dictated by member roles, capital contributions, or performance metrics.

Most importantly, state when and how often member distributions will be made. This can be scheduled regularly, quarterly, annually, or whenever your LLC has enough cash flow. Include additional clauses for investing earnings into business growth and reserving funds for unexpected expenses or opportunities.

Tax Distributions

Your partnership agreement should cover tax distributions as well. With provisions governing these distributions, you ensure that each member receives enough funds to meet their tax liabilities.

Your LLC’s tax distributions can be equal to its taxable income multiplied by a specific tax rate. The total amount represents a member’s tax liability on their share of pass-through income and establishes the final size of the distribution. Then, you’ll need to choose the best tax rate. The process guarantees that all members pay the taxes imposed on them.

At the very least, include clauses for managing tax adjustments, amended returns, and audit situations in your partnership agreement. You should also designate a member or an external party to a role related to tax compliance and detail how associated costs will be shared among members.

Other Information to Include in a Partnership Agreement

Besides the clauses we’ve discussed earlier, your LLC’s partnership agreement should include the following information:

• Basic details about the business, including its legal name, address, and any appropriate statements
• The LLC’s management structure – State whether the business is a member-managed or manager-managed entity. Member-managed LLCs allow all members to handle daily operations, while manager-managed LLCs designate selected individuals to manage the company.
• Procedures for resolving member disputes – Drafting a partnership agreement with this information can help prevent lawsuits, just like an LLC’s operating agreement does. Potential disputes can be resolved through mediation or arbitration.
• Procedures for urgent decision-making – If certain decisions must be made immediately, your partnership agreement can leave this task to designated members. It should also state which decisions should be made promptly.

Nevada Law & How It Applies to Partnership Agreements

Forming an LLC in Nevada offers advantages such as potentially fewer state tax obligations and strong privacy protection. If you plan to start your business in the state, make sure to draft a partnership agreement that adheres to the Nevada Revised Statutes Chapter 86.

NRS Chapter 86 governs an LLC’s operations and member relationships. Under this set of regulations, Nevada LLC members can manage the business however they choose. Moreover, their ventures can create classes of members or managers with specific rights, powers, and duties. Your partnership agreement can include clauses based on these rules.

LLC Partnership Agreements vs. Operating Agreements

The terms “partnership agreement” and “operating agreement” are often used interchangeably. However, there are some significant differences between the two.

A partnership agreement governs an LLC with various partners. It’s a document that covers member relationships, contributions, and management processes. Meanwhile, an operating agreement formalizes partnerships within your LLC. It includes clauses about the venture’s operations and each member’s financial and managerial rights.

Bonus Tip: Learn how to write an LLC operating agreement from the NCH blog.

Frequently Asked Questions

What’s the difference between a partnership agreement & an operating agreement?

A partnership agreement applies to LLCs with members in established relationships. It addresses aspects such as ownership percentages, membership changes, decision-making, and profit and loss sharing.

Conversely, an operating agreement dictates how the LLC operates and what each individual is entitled to during their membership.

How should ownership percentages be determined for fair distributions?

Ownership percentages should be determined based on each person’s capital contribution to your LLC. You may also want to hire a professional appraiser to determine the value of these contributions and set clear metrics from there.

What happens if members disagree on major business decisions?

If members disagree on major business decisions, you should implement the necessary procedures outlined in your partnership agreement.

For example, the document should state how your LLC can break deadlocks. You could conduct mediation, consult a neutral third party, or use another method to resolve deadlocks.

Can profit distribution percentages be changed after LLC formation?

Yes, profit distribution percentages can be changed after LLC formation. Please note that this decision needs member approval, and you must establish how profits would be distributed moving forward.

Once the change takes effect, document it properly and consult tax advisors about potential tax implications.

Learn About NCH’s Tax Consulting Services

How should my LLC handle members who want to leave the business?

Your LLC should handle members who want to leave the business according to the procedures outlined in its partnership agreement. These processes vary by the type of member departures, mostly classified as voluntary and involuntary exits.

For instance, a retiring member may need to notify your LLC of their departure. Valuation and payment can be done from there.

What voting percentage should be required for major LLC decisions?

Major LLC decisions usually need 66% or 75% of member votes. Any of these percentages equals a supermajority vote for decisions such as settling significant debts and changing how profits are given to members.

Conversely, your LLC will need unanimous consent (100%) if it decides to amend its operating agreement, close, or sell assets.

What makes an LLC partnership agreement different from a shareholder agreement?

Again, an LLC partnership agreement governs LLCs with multiple partners and focuses on areas such as member roles, profit distribution, and decision-making. A shareholder agreement is made between a company’s shareholders and details their rights and obligations. Overall, it protects the business and its shareholders’ investment.

Can my LLC create multiple classes of members through a partnership agreement?

Yes, your LLC can create multiple classes of members through a partnership agreement. Based on this information, you could have a “Class A” with the LLC’s managers, a “Class B” with passive investors, and so on. Your partnership agreement should outline the rights, responsibilities, and profit-sharing arrangements of each class.

How should conflicts between LLC members be handled?

Conflicts between LLC members should be handled using the processes stated in your partnership agreement. For the most part, you can require mediation or arbitration to resolve potential disputes.

Can ownership percentages change based on performance or contributions?

Yes, ownership percentages can change based on performance or contributions. When these adjustments are addressed in your LLC partnership agreement, your business can reward active members or those adding a significant amount of capital. Plus, it protects the LLC’s interests and compensates all members fairly.

Expert Tips From NCH

1. Review your partnership agreement to see whether it still meets your LLC’s needs. Member roles, the amounts of capital contributions made, and other priorities may change with your operations.
2. Establish clear and open communication between your LLC’s members. Consider scheduling regular meetings, preparing standardized financial reports, and documenting all procedures related to your operations to avoid disputes.
3. Track each member’s capital contributions, share of business profits and losses, and other distributions. It’s essential for reporting accurate taxes, calculating buyout amounts, and ensuring fair distributions.
4. Include thoroughly defined clauses about adding new members to your LLC in its partnership agreement. Outline how new members will be evaluated, who will approve their admission, and how it would affect existing members’ ownership percentages and rights.

Bonus Tip

Learn the basics of a partnership agreement from NCH’s 60 Second Business Tips series.

Strengthen Relationships Within Your LLC

An LLC partnership agreement is key to successful business relationships between an LLC’s members. It covers and defines everything from ownership interests to decision-making processes. With a comprehensive and clear partnership agreement, you ensure that your business grows while protecting all members’ interests. Moreover, the document should also be reviewed and updated to stay effective and legally compliant.

Do you need help drafting your LLC’s partnership agreement? NCH’s legal experts can review your document and suggest necessary changes for smooth operations.

Contact Us for Legal Advice Today

DISCLAIMER: The above material has been prepared for informational purposes only, containing opinions of the provider and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. Please consider consulting tax, legal, and accounting advisors before engaging in any transaction.