After you form a limited liability company, the first thing you should do is draft an operating agreement. And if you’ve already formed a limited liability company or you’ve already formed any kind of entity, you want to draft the equivalent of an operating agreement, as an internal document among co-owners. If you’re all alone, you don’t necessarily need one, but the bank may require one. If you’ve got partners or other members or owners in your business, you want to draft an operating agreement from the beginning.
When a new business owner starts a business, you’re excited, you want to go out and make your first sale. Probably the last thing you want to do is engage an attorney and spend money out of pocket before bringing in any money. And that’s really what an operating agreement unfortunately does. You’re going to have to invest some time and energy in getting the agreement right. But the benefit for you in the long run is tremendous because in the very beginning when everybody is happy and everybody is getting along, you can think objectively about the issues that need to be addressed in an operating agreement, such as equity from principals, family, friends and third parties.
If you’re dealing with incurring bank loans, whose obligation is it going to be to repay these loans? The bank obviously will look to the company to repay these loans but you have to be careful about personal guarantees. Are you going to treat all the members of the company equally? Will everyone have the personal obligation to repay a bank loan? That’s something you want to address with your fellow owners from the beginning.
On the same note, buy-sell provisions are important. What happens when someone inevitably wants to transfer their interests or if someone were to pass away? Or maybe you’ve got two business partners, and they both want to add a 4th business member to your company, but you don’t want to add that member. Address those issues in the beginning. It’s going to be easier for you when they come up in the future.
And if at a future date you want to revise your operating agreement because you’re all thinking about things differently, that’s fine too. They’re easy enough to revise, but it’ll at least give you a frame work, a starting point on how to move forward when facing these real significant issues.
Another real critical issue for every small business owner is distribution. When you’re trying to pull money out of a company, you’re trying to get paid for all of your hard work and effort. How are you going to do that in line with the other members of the company? What will it take to get everyone to approve? Who has the right to pull out money, what amount and so forth? These are very important issues to think about and address from the beginning. And voting on all of these issues is something you want to consider. Put some rules in place, particularly if you’ve got three, four, five members or more. Is it going to take 51% of the people involved in the company to perform an action? Will it take 100% for something more extreme, such as adding a new member?
Try and think about some of these issues. Most attorneys will be able to give you a list of some of the critical events that you should consider, and you can go back on your own time, talk to your fellow partners, and decide how you’d like to address these things in the operating agreement.
Published: August 8, 2013