What Should Be Included in an Operating Agreement?
Ownership: This goes far beyond just deciding what percentage of the entity each partner owns. Many other questions need to be answered as well, such as:
- Is your business willing to take on new partners? If so, what percentage are you willing to sell to a new partner, and how will the other partners’ percentages be diluted in such a transaction?
- If one of the partners wants to sell his/her percentage, what are the buyout options for the other partners?
- Under what circumstances can a partner be terminated/removed from the company?
- If one partner sells out, what safeguards do the other partners have that the exiting partner will not compete against them and steal their clients?
- What happens if one of the partners dies? Will the company set up key member life insurance so the others can buy out the deceased partner’s percentage?
Contribution: What is each partner’s stake in financing the formation and ongoing operation of the business? The operating agreement should clearly define not only how much capital each partner will put in, but also how much time, effort, and other resources they will provide.
Distribution: What salary (if any) will be paid to each partner? How will profits be distributed? Will some or all of the profits be reinvested in the business? If so, for how long?
Decision-Making: This is very important, because it is the source of many conflicts. The operating agreement should clearly define how decisions are made and who has the authority to make which decisions about company operations. For example, will some areas of decision-making require a majority vote? For the decisions that do not require a vote, who has the final say?
Dispute Resolution: How will partnership disputes be handled when they occur. Will partnership mediation be the first step? Will you go to binding arbitration to settle differences? Litigation is costly, time-consuming, and becomes part of the public record. For this reason, it is best to choose an alternative form of dispute resolution if the need ever arises.
Dissolution: Your operating agreement should list the steps that need to be taken to legally dissolve your entity. This makes the process much easier if the day ever comes when the owners decide to close up shop and part ways.
When you go into business with one or more other individuals, it is important to take the time to set up a comprehensive operating agreement. With a well though-out agreement in place, you can rest easy knowing that the important issues have been covered, so you can focus on running your business.
At AMS, we provide expert guidance with operating agreements. Putting our extensive experience to work, we can help you and your partners craft an agreement that thoroughly addresses your needs and makes sense for your business. After the components of the operating agreement have been agreed on by all parties, the document should be drafted and reviewed by an attorney to make it legally enforceable.
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