What’s In Your Operating Agreement?

Every limited liability company should have an Operating Agreement. It is amazing how many business people approach us, who have a legitimate problem with a partner, and who either have never signed an Operating Agreement, have executed a cheap form Operating Agreement found on the internet, or simply lost the one that the partners originally signed.  Common sense suggests that having an airtight Operating Agreement would be a worthwhile investment. However, for a lot of business people, that is simply not the case.

Here are some suggested items that should be included in an Operating Agreement and how business owners should get one done.

1. Have Your Lawyer Draft the Operating Agreement.  An operating agreement can be a very complex document. A draft should be undertaken by a trained professional; it should not be based on a form you pull from the internet.
2. Make Sure You Know Who the Boss Is. The worst thing any kitchen can have is too many head chefs. Someone needs to be in charge, generally referred to as the “Managing Member.” Make sure to choose the “Managing Member” before you draft an Operating Agreement.
3. Include a Tie Breaker. Many small businesses have only two members. However, it makes sense to have three members eligible to vote in order to avoid a “deadlock.” A disagreement among members can paralyze a business and cause a virtual shutdown.
4. The Direct/Derivative Distinction. At some point you, as a member, may be harmed by something that one of your co-members does (or does not do).  You may be faced with having to sue the other member. However, unless your operating agreement provides you with a specific right to do that, you may be stuck having to file a Shareholder’s Derivative action which is considerably more time consuming and expensive. You may be able to eliminate this problem by including a provision in your operating agreement that allows for direct claims.
5. Getting Out. You want to make sure that your operating agreement has a provision that allows you to sell your interest to a third party or back to the company. There is no point in having an investment that you cannot sell. This provision can be particularly useful if you want to sell, and the other members do not.
6. Distributions. There should be a provision in your operating agreement which establishes how distributions are made, in what percentages and what will trigger such a distribution.  The last thing you want is to be in a fight with your partners about how to divide up the money.

There is no substitute for a tightly worded well considered Operating Agreement. If there will be points of contention, or disagreement among partners, the best time to have it is at the beginning, not after the business is already operating.  Competent counsel can certainly assist in this task in order to prevent costly litigation later on.