You’ve officially started a business with your best friend. You are excited, the market looks extremely promising, and you have officially decided you are going to register your business with the Secretary of State. But do not forget about the all too often neglected operating agreement.
When all is going well in the early days of your business, an operating agreement appears to be a substantial waste of resources and time. After all, you and your buddy are building this business on good-faith, you trust each other, and have agreed on how the two of you are going to divide future profits. Plus, even if the two of you do have a disagreement in the future, you’ve always worked it out in the past so what difference does it make?
Don’t fall into this ruse. Failing to have an operating agreement can destroy everything you work for. Worse than that, failing to have an operating agreement can jeopardize the business, your profits, and most importantly, your friendships. Commit to having an operating agreement in place when you launch your new venture.
What is an operating agreement?
An operating agreement is a legal contract that describes the operations of your limited liability company (LLC). This contract sets out all the terms and conditions agreed to by the members of the limited liability company (LLC). The operating agreement contains every contingency, each day-to-day operation, and all responses to special circumstances (a member leaves the LLC, gets divorced, or dies).
The whole goal of an operating agreement is to oversee the internal operations of the business in a way that suits the specific needs of the business owners. Once the document is signed by each of the business owners, it acts as the official law of the company, binding each member to the agreement terms.
Here’s what should be included:
Operating Agreements Key Elements
There are endless amounts of provisions that can be added to an operating agreement, but your operating agreement should contain the following:
Your operating agreement should specify how major business decisions will be made. This agreement will govern the relationship between you and your buddy in a majority and the minority on every decision.
The agreement should also contain how the profits and losses will be divided amongst the members. More specifically, the contract should explain when/how the distributions (payments) will be completed. Remember, LLC members will pay taxes on profit no matter how or if the profits are distributed, so decide if you want distributions to be made quarterly or if they can be withdrawn whenever.
Tough but necessary: Your agreement should absolutely contain provisions for how you will address the addition and removal of members. The agreement should also include what circumstances can lead to the removal or addition of a member. In this section, you should also include the ownership of each member, the services rendered by each member, and the requirements of each member.
Furthermore, your operating agreement should include a managerial structure and the roles that each member has during decision making. Will there be decisions that will require a vote? Can large decisions be made without discussing it with other members? If there is a vote, how will the vote take place?
Simple vs. Complex
An agreement can be as simple or complex as you and your buddy decide it to be. In the operating agreement attached below, you will see a very complex operating agreement. Every provision added in this agreement won’t be necessary for your business but is highly recommended. Just remember, your operating agreement will act as a continuous rule book to solve company problems, so set as many provisions as possible.
An End Is Inevitable
There will be a time in your life that you will want to walk away from being one of the main members of your business. Your operating agreement is the best place to include what the plan is for the dissolution (ending) of the business. The agreement should include how each member would like to see the company end while everyone is still in a cooperative state.
An operating agreement can make or break the future of your company. Take it seriously. Take your time. And do it right.