Defining an Operating Agreement
An operating agreement is a legal document that lays out the management of a limited liability company (LLC). Its purpose is to clearly establish the operational structure and financial principles of the business. Certain rules for running an LLC set forth in the state code or statute can be modified or eliminated by the operating agreement. An operating agreement functions similarly to the bylaws of a corporation and is crucial for defining the operational structure and financial principles of a company.
The operating agreement is an essential component of an LLC . Because an LLC is a hybrid form of business entity, it is not strictly regulated in the same manner as a corporation. Despite this, the operating agreement does require certain disclosures that include the financial role of investors, as well as their voting rights in matters of business management. Many investors have opinions on the running of a business, and an operating agreement serves as a way to decide beforehand how the equity will be distributed and what duties should fall upon each specific member.
The Reasons for Working with an Operating Agreement Attorney
An Operating Agreement Attorney can help draft or review the terms of an operating agreement to ensure compliance with state laws and various other statutory requirements. The attorney will ensure that the Operating Agreement is drafted from the point of view of your business interests, as opposed to leaving some provisions in there for the sake of having something and not really paying attention to how those provisions will affect your business if brought into play. In addition, they will ensure that the agreement is written clearly enough to avoid future disputes over any ambiguous portions. As a result, you can be sure that the Operating Agreement represents a true picture of what you and the other members wish to achieve and provide a much better basis for any future business dealings the company may enter into.
And the best part is you get this level of service at the same or cheaper prices than the standard boiler plate "drag and drop" services you will find out there.
Components of an Operating Agreement
An attorney will want to consider the following as they put together an operating agreement for a client:
Management Structure: The management structure should be identified. You may have a manager-managed or member-managed structure. Individuals may be designated as managers of the company.
Roles and Responsibilities of Members: Even if you have an operating agreement, you should always define the roles of the members. If you have a manager-managed structure, information may be included identifying the responsibilities of members versus the responsibilities of managers.
Voting Rights: Voting rights can be defined in the operating agreement. Voting thresholds may also be included; voting may be established for amendment of the operating agreement, for example. Majority voting can be discussed.
Distribution of Profit/Loss: The distribution of profits and losses can be outlined in the operating agreement. Distribution of distributions can be structured differently than distribution of profits and losses, such that distributions may be made equally to members, regardless of ownership percentages in the company.
Dissolution Procedures: Dissolution procedures can be defined in the operating agreement. The process of how the remaining members will go about dissolving the company and winding up the business can be described in detail. A member may also consider including in the operating agreement procedures for an exit, such as establishing a buy-sell mechanism for situations where a member wants to leave the company or a member dies.
Mistakes to Avoid
Businesses often attempt to save money by drafting their own operating agreements, which can lead to significant issues down the road. However, these problems are easily avoidable with the help of an attorney who specializes in this area. Common difficulties include:
Prioritize Clarity Over Complexity
Variation among agreements is typical since a single boilerplate approach cannot apply universally, and many agreements are made specifically to suit a particular case. However, complexity isn’t the only reason for difference between agreements. Some companies create intentionally complex agreements to dismiss component parts of the agreement that they don’t want to or need to address . Such an approach is not only disingenuous, but it can also result in the dismissal of key aspects of the agreement, or complete dismissal of an entire agreement. An attorney will draft a straightforward, easy-to-digest agreement protecting the most common areas attacked by parties seeking to undermine the contract or the company.
Consider All Possible Scenarios
There is no one-size-fits-all approach to drafting an operating agreement. Firms develop unique procedures that must be articulated in the agreement. Continuing to follow those procedures after the agreement is signed can become costly or even dangerous. An attorney will help you avoid these traps by discussing all of your options before making any decisions pertaining to your operating procedure.
Finding the Right Operating Agreement Attorney
Given the myriad of factors to consider when selecting an operating agreement attorney, including experience, reputation, and record of successful transactions, you will want to review each potential business attorney very carefully. In order to choose wisely, you may consider asking an attorney the following questions:
How Long Have They Been Practicing? Experience is one of the most important things to consider when choosing an attorney, especially for something as important as preparing an operating agreement. The longer they have been practicing, the more likely you are to be hiring a professional who will prepare a suitable operating agreement.
How Many Operating Agreements Have They Prepared? Equally important is how many operating agreements they have prepared. If an attorney spends most of his or her time preparing other kinds of agreements, you may question whether you want him or her to prepare yours. You may not receive the attention to detail you deserve. Ideally, you want to go with an attorney that specializes in forming limited liability companies and preparing operating agreements.
How Have They Helped Other Clients? A good place to start your search is by reading reviews of the attorney online. Sites like LinkedIn and Google Maps have loads of reviews of businesses. If you see lots of bad reviews, you can probably eliminate that business from your list. However, if lots of recent clients have provided positive reviews of the attorney, you can feel pretty confident that he or she will also care about you.
How Much Do They Charge for Their Services? Business attorneys often charge a flat fee for preparing operating agreements. However, it’s still a good idea to get some quotes before signing a contract with a particular lawyer. The price can vary quite a bit from attorney to attorney. However, it’s likely that the experience level and specialization of the attorney will correlate with the price. A good attorney is a valuable investment.
Success Story: When an Operating Agreement Works
Consider a scenario where three individuals, Allie, Bill, and Clara, decide to start a consulting firm. Allie brings in a significant client base and industry experience, Bill has funds to invest, and Clara has the time and a great marketing strategy. They agree to equally split all profits and losses, as is customary with a partnership. No formal operating agreement is created at formation, as they have a verbal agreement on how to divide everything and just want to get started.
As often happens, various issues arise. When the first client payments are received, Clara notices that Bill has taken a larger share of the funds and Allie refuses to explain what the client base is worth. A disagreement also erupts between Allie and Bill about how expansive the firm’s expertise should be (Allie wants to focus on healthcare clients and Bill insists they also take on some tech clients). Clara then gets tired of the conflict and determines she wants to pull out of the agreement .
What happens next?
Without a written operating agreement, Bill and Clara do not have any recourse under the law to force Allie to share the client base information. When Clara wants to pull away from the business, she finds out that in accordance with state default laws, Bill and Allie are entitled to freeze her out of the firm, unless they agree otherwise (which they do not, as they want to preserve the firm’s value). So Clara leaves, and can now start her own firm against Bill and Allie within one year (which she promptly does, taking their biggest client away). Bill and Allie are left to run a small, struggling firm and have to spend thousands of dollars litigating against Clara. Bill also convinces Allie to drop the healthcare clients and focus instead on tech. However, Bill does not have a strong network in the healthcare space, and the firm’s net return suffers.
Had Allie, Bill, and Clara created an operating agreement initially, and had it drafted and reviewed with an attorney, the parties could have avoided these predictable and costly pitfalls, to say the least.