Starting a business can be stressful. A good way to ensure you complete all the required and suggested business startup tasks is to break the entire process into manageable steps. If you are forming a partnership, one of the first essential tasks is to create an operating agreement. While there are many operating agreement templates out there, you should create a unique one to fit your partnership.
What is an operating agreement?
You can think of an operating as a the “ground rules” of your partnership in written form. Most business partners start with the best intentions, and no one forms a partnership with future problems in mind. However, running a new business is a stressful, complex endeavor and it can push people in ways they did not foresee.
An operating agreement is not necessarily a legal document. However, to form an LLC, you need to have some sort of signed operating agreement in place.
So, what are the points that would be considered the bare minimum in the first version of an operating agreement?
It is absolutely essential that each partner agree on percentage of ownership for each partner. Not all partnerships are split 50/50. Often, one partner does more actual work than the other. It is important to note that, in order for a person to be a partner in an LLC, they cannot just be a passive investor. They must have material responsibilities which they discharge in the course of running the business. This is not to say that a new LLC partnership cannot have passive investors.
In general, the goal of a business is to generate profit. Partners must agree on the distribution of those profits. It may sound simple; if it is a 50/50 partnership and the business nets $1000 in a week, each partner gets $500, right? Wrong. In order to grow the business, a certain amount of profit should be reinvested into the business. Additionally, depending on the selected tax structure, profits can be distributed in different ways. For example, a business formed as an S-Corp can distribute profits weekly, monthly, quarterly, etc.
In a partnership, many people learn quickly that having defined roles is important. You do not want to debate every minor decision during the course of running the business. An operating agreement should define those roles, so each partner not only knows their job description, but so everyone is held accountable. Also, defining roles is a requirement in some cases.
Hardly anyone forms a partnership with dissolution in mind, but most businesses fail at some point. There should be an agreed upon process in place in the event of dissolution. Does each partner immediately get a share of liquid cash? Do you divide inventory evenly amongst partners or continue to sell and split the revenue? What if only one partner wants a buyout? All these things should be decided beforehand.
Other important things to cover are arbitration, initial investments, and consequences if a partner violates the operating agreement.
If you are forming a business, you may learn that it can be overwhelming. Laws are not written in laymen’s terms. To get started on the right foot, contact Elias Dsouza at Dsouza and Strachan Law Group today for a free consultation.