Instructions for Your Operating Agreement
Business Law for Entrepreneurs Series
By Adrienne B. Haynes, Esq.
Managing Partner, SEED Law
When you start a limited liability company, most states will require the preparation of an operating agreement. An operating agreement is an internal document that outlines the legalities around business ownership, including equity divisions, management, decision making, and exit provisions.
In the operating agreement, the provisions should respond to your state’s corporate laws and ensure that key information is not only documented in your mental hard drive as a founder or leadership team.
· Who owns the business?
· How are decisions made as a leader or leadership team?
· How are new owners brought in?
· How can owners transition out? What happens if there needs to be a vote out or forced removal of a partner?
· What happens to one’s ownership stake in the case of disability, divorce, or death?
Whether the business is owned by one person or several, taking the time to develop an operating agreement gives the founder(s) time to consider important business decisions and details, and to put them in writing. This process minimizes the guess work in conflict, making it easier to make, grow, and have trust in the relationship. Without this document, in the case of triggering events, the law may dictate how your final business decisions are made through statutory defaults.
For example, let’s say you want to start a construction business with your friend. After some discussion, you decide to file an LLC and enter into a six-month lease at a local shopping center to provide an in-person location for your clients to visit. After sending your articles of organization in to the Secretary of State with a few questions, you meet with your business partner to sign the lease and get started on building the business.
Fast forward ninety days, and you’re realizing that the two of you have really different business ideologies and communication styles and that at this rate, you’re not interested in making any additional investment into the business. It’s hard to have conversations at this point because it’s emotional and there is money involved, and you don’t have anything in writing about how to close the business and get out of this. Your friend wants to bring her cousin in to “buy you out” and you are going to meet later this week at happy hour to discuss the terms.
This is just a basic example, but it highlights a few complexities of jumping into business without discussing or considering the “what ifs”. After five years of practicing entrepreneurial law, I can tell you that I’ve helped with more than enough “horror stories” where people come to us a little later than they could have.
Even if you don’t have a business partner, preparing an operating agreement is a responsible decision as an owner.
For example, let’s say you are a fairly successful app developer and have begun to take on a few projects outside of your day job. The money is good and the work is stimulating. You have a consultation with two law firms but decide to file the LLC on your own just to protect yourself for now. You have three clients now and after a few more, you’ll allocate the funds to think about a pro team.
On your way to a coffee meeting, you were on snapchat with your girls and got into a tangle with a speeding bike. Unfortunately, the bike won and now you have to spend some time off work recovering. In fact, you’re out- really out — for almost three months. Your clients are upset because their projects are delayed and one even wants their money back. After weeks of constant calls and a slow recovery, you’re stressed, irritated, and honestly ready to close the business. You’ve also been thinking about making a will and realize you don’t have anything in place for what should happen with your business if something happens to you.
An operating agreement is to function as a guiding document for major decisions between business owners and includes business owner preferences when they may be unable to communicate their final wishes. When you start a business, it’s also the right time to begin to develop your succession and exit planning documentation. You never know, there could be an unplanned global pandemic (too soon…).
Once you get your agreement prepared, PLEASE SIGN IT. You’d be surprised how many businesses pay for good legal counsel, only to leave the long-negotiated agreement without the necessary signatures. Not SEED Law clients, of course. Lastly, even when you have all of your “i’s dotted and t’s crossed”, it’s important to have all of your business agreements reviewed every 2–3 years to ensure that they are still consistent with the law and with the way you want to do business.
This article is an overview of formation considerations, including governing documentation and key terms, and does not cover every legal right or obligation, consideration, exception, or restriction. These documentations and decisions are complex and should be well researched and discussed with a professional before being made.
To schedule a consultation with a SEED Law attorney, you can give us a call a (816)945–4249 or schedule your consultation today here.
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