Advantages of an Operating Agreement:
The Operating Agreement outlines the structure of your business. If there are multiple owners, the Operating Agreement will clearly assign a percentage of the business to each owner, and specify what each owner’s share of the profit is. A well-written Operating Agreement is an effective way to avoid expensive legal disputes during the lifetime of your business; without it, your business will be governed by the default operating rules based on your business’ structure. In addition to including information about how profits will be divided, your operating agreement could have information about holding meetings, making decisions, and individual member’s responsibilities. The Operating Agreement can also define what happens in the event of a partner’s death.
Essential Elements of an Operating Agreement:
Ownership Division: Your Operating Agreement should specify how the percentage of ownership of the business is based; whether it be based on financial contributions, or other factors. Also, be sure to specify whether the percentage of ownership is directly reflected in the pay each owner receives, and/or by the percentage of management influence; as indicated by each member’s percentage interest in the company, for instance.
Payments: Your Operating Agreement should clearly indicate how losses and gains are to be handled, and whether partners are to be paid in the form of cash distributions or company shares. Payouts can be a complex taxation issue for both the partners, and the business; this aspect of the Operating Agreement benefits from the input of an accountant or a lawyer.
Business Management: The Operating Agreement ought to specify how the business will be managed. For example, in the Operating Agreement you may designate who will be responsible for certain elements of the operation, who will have the final decision, what percentage of members are needed to make what kind of decisions, etc.
Plan for Unexpected Events that Could Change the Structure of the Company: An Operating Agreement is most effective when it takes into account most of the eventualities that might arise, especially those that are a threat to the company. For instance, your Operating Agreement should specify what would happen if there is a death of a partner, if a partner wishes to sell his or her share, or if the company is dissolved. The companies’ Operating Agreement is most effective when it accounts for contingencies that might arise.
Every business should have an Operating Agreement; even in situations where partners trust each other enough to believe it would be unnecessary. An Operating Agreement is a simple method to avoid legal disputes, and to help clarify elements of the operation, management capacities, and the division of ownership. Even if you believe an Operating Agreement is excessive, it is always a wise decision to create one for your company. Likewise, if your business already has an Operating Agreement, but you believe it may be out of date, and/or it does not reflect your current circumstances, it might be time to update the agreement.