What is an operating agreement?
An operating agreement (aka partnership agreement) is a legal document which (1) details the set-up of a limited liability company; (2) establishes the rules the limited liability company will be governed by; and (3) establishes agreements between the owners (“members”) of the company regarding management control and ownership.
Are operating agreements a one size fits all document?
Usually, they are not! Although you can find generic bare bones forms online which cover some of the basic information needed in an operating agreement, most of the time these documents will be insufficient for many companies. The below points illustrate why this is the case.
- Ownership: The only thing protecting you if an employee, spouse, boyfriend or girlfriend, claims that they own some or all of your business is proper documentation evidencing ownership. Most generic operating agreement do not contain enough information regarding ownership. This should be of primary concern for the owners of the business.
- State Law: Operating agreements are normally governed by the laws of the state of formation of the limited liability company, and many of the templates you find online are not state specific. For this reason, when you use a generic online template originally created for the state of let’s say Maine it may or may not fit for the laws of the state of Delaware or Florida, which could contradict state law and thus make provisions in the operating agreement inoperable.
- Management: Just because you formed the entity does not mean that you have the long term right to manage the entity. An operating agreement should designate management control of the entity and provide rules for adding and removing managers, officers, and other types of representatives.
- Multi-Member: member’s aggregate rights, profits are allocated and distributed, share in the LLC’s profits and losses; receive distributions from the LLC; and vote and participate in the LLC’s management. how an initial capital contribution will be made, whether by cash, tangible or intangible property, services rendered, promissory notes, or other obligations means and conditions for amending the operating agreement
- Restrictions on the sale of the company: Whenever someone owns your company besides you there is always a risk that they could transfer that ownership to someone you do not like. If you do not have a provision to the contrary, members of your company can transfer the shares to whoever they want (your enemy, punk kids, terror spouse, etc.) and you cannot do anything about it.
- Buy/Sell Provisions: Where the members are each working in the company and one stops working for whatever reason (death, retirement, quits), without a provision regarding what happens to the ownership interest, the member who stopped working keeps the membership interest and becomes a freeloader. A change in management and/or employment status does not control a change in ownership unless the operating agreement sets it up. Generic operating agreements normally do not have buy/sell provisions or do not tailor them to specific needs of the business owner.
Make sure the generic operating agreement matches what you are doing?
I cannot count the number of times I reviewed a generic operating agreement and it did not match the management structure, ownership structure, or some other part of how my client ran their business. If you use a generic operating agreement you need to read it and follow it because you are contractually obligated to do so. But please, if it says you are member managed do not appoint managers, or vice versa.
Sign your documents?
If you are going to use a generic operating agreement or other documents make sure all necessary parties sign them. If you do not sign it, they do not count, and it is as if you had no operating agreement at all. So, PLEASE sign your documents.
When am I safe to use a generic operating agreement?
If you are the sole owner of your own company, you have no business partners or potential partners, you are in good health, you have only a single beneficiary if you die, your company does not have a lot of value, you are not planning on selling the company, you are not planning on applying for loans or entering into large contracts with the company, then your exposure is lessened and although you still have some risks associated with a generic operating agreement, a generic operating agreement may work for you.
If you are wondering if your operating agreement is strong enough, our attorneys at Forward routinely draft, review, and negotiate operating agreements. We would love to speak with you regarding your concerns and ways your agreement can be improved. Contact us today!