Operating Agreements (now called Limited Liability Company Agreements in many states like Alabama) might be one of the most boring topics you could face when starting your business. However, the Operating Agreement is designed to mitigate the single biggest threat to the success of your business.

Many people are familiar with the rates of failure of startups. Roughly one half to nine in ten business fail in the first few years, depending on what metric you use. Most people don’t know that one of the top three reasons that businesses fail is a breakdown in the working relationship between the business owners. The Operating Agreement is the contract that is supposed to at least minimize these types of disagreements.

An LLC’s Operating Agreement is the binding contract signed between the LLC and its owners clarifying what the respective parties’ obligations and rights are.

Dwight Eisenhower famously said, “Plans are worthless, but planning is everything.” Your Operating Agreement is your plan. Yes, it’s probably not going to protect you when your product doesn’t sell at market, but if you properly do the work of discussing with your partner the hard questions, maybe you’ll have an idea how to proactively respond in those situations instead of simply reacting.

Here’s some topics you need to address when putting together an Operating Agreement:

Who is an Owner?

This might sound overly-simplistic, but in an LLC a “partner,” a “member, a “president,” a “manager, and a “CEO” could all have completely different meanings from one LLC to the next. In some LLCs, they might even all mean the exact same thing. Some imply ownership, some don’t. Your Operating Agreement should be very clear on who has an ownership interest, and, even more importantly, what that ownership interest entails.

Define Responsibility

One of the most common issues for partners is differing work expectations. Many entrepreneurs work 50+ hours a week. If a partner can’t or won’t work those hours, that needs to be honestly discussed before you get started. Within those work hours, you need to determine who is going to do what.

Limit Authority

Likewise, you need to limit what other partners can do. Most Operating Agreement prevent a single partner from shutting the business down, but what processes should be observed, if any, if that partner needs to incur a $50 expense? a $500 expense? $5,000?

Plan for Financial Contingencies

In a best case scenario, you make money. In all likelihood, though, you’ll probably have to pony up a capital call or two. In both scenarios, you need to have a clear plan on what happens. Default rules in LLCs do not favor sweat equity partners, so if you’re going to pay wages, that has to be clearly defined.

Bottom Line

I know it’s tempting to just pull some standard agreement from the internet or from everyone’s favorite volume discount legal services vendor, but I cannot tell you how many times I see those form agreements blow up in everyone’s faces. If your company has two partners, taking the time to prepare an Operating Agreement is invaluable. If you have three or more owners, not having a customized Operating Agreement is likely to doom your fledgling business to failure.

If you need assistance with an Operating Agreement or with other issues relating to your business, contact us!