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Disclaimer: We are NOT lawyers; we recommend consulting with a lawyer for any advice specific to your situation or before making any big decisions.
In post 2.2.3 (step 6), we introduced the concept of an operating agreement, if you haven’t read post 2.2.3 start there. In this post, we’ll go over what is included in an operating agreement, the benefits, and how to craft your own.
What is an Operating Agreement and What to Include?
An operating agreement is a documented and agreed upon set of parameters for a business, the intent of an operating agreement is to provide structure and clarity. Below are some key components (not comprehensive):
Member & manager information, including names, contact information, roles, etc. to paint a picture of who is involved in managing and owning the business
What we did: we listed out the above information for both Nick and Amanda in addition to the business purpose and formation date
Capital contribution, which specifies the amount of money or assets each owner has contributed to start the business and how additional funds will be handled as needed
What we did: Amanda and Nick both invested 50% of the total investment
Voting rights to outline the voting rights and decision-making processes among members
What we did: We didn’t feel like this was necessary for us, but could be helpful if the workload isn’t evenly distributed or there are a lot of members & managers.
Profit & loss distribution to detail how profits and losses will be allocated among members
What we did: Amanda and Nick each have a 50/50 distribution of profits and losses and will review profits/losses on an annual basis
Reimbursement of expenses - how managers are compensated for their work, how business expenses are reimbursed, and which expenses are payable by the business
What we did: we didn’t have any manager salaries and all business expenses incurred are paid by the business credit card
Powers and duties, which outline what managers can and cannot do. It details their responsibilities, such as property management, guest interactions, maintenance, managing finances, and their authority limits such as dispute resolution
What we did: We had a bulleted list of the items that Nick (e.g., taxes, property maintenance, etc.) was accountable for and a list for what Amanda is accountable for (e.g., guest interactions, scheduling the cleaner, ordering supplies, etc.), you can go into detail on how each person does each of their tasks if you wanted to, but we didn’t feel like it was necessary
Indemnification protects managers and members from legal expenses incurred while performing their duties for the business, provided they were acting within the scope of their roles and not engaging in negligence or misconduct
What we did: we used the standard indemnification clause that LawDepot provides
Transfer of membership interest, which explains the rules for a member who wants to sell or transfer their share of the business to someone else, including any restrictions or required procedures
What we did: we used the standard template that LawDepot provides
Dissolution procedures to provide the steps to follow if the business is to be closed, including how assets will be distributed, how debts will be paid, and other legal requirements
What we did: we used the standard template clause that LawDepot provides
General Provisions: A catch-all for other legal stipulations not covered in other sections, such as how the agreement can be amended and which state laws govern the agreement
What we did: we didn’t add anything here, but this is where amendments would reside
The above are common items to include in an operating agreement, you should make your operating agreement work for your business so feel free to add additional components.
6 Reasons to Draft an Operating Agreement
We recommend having an operating agreement, especially for business with more than one member/owner. A few reasons operating agreements are beneficial:
Helps to set expectations early to avoid disputes once operational - say it comes time to distribute profits and your partner thinks they deserve more than you, they’re less likely to feel slighted if expectations are discussed ahead of time.
Enables you to think through how to operationalize your business ahead of time to avoid rash decisions later on - say your cleaner unexpectedly isn’t able to clean your place, you can reference operating procedures you set ahead of time so you’re not paying an arm and a leg for a cleaner that you haven’t vetted.
While laws provide default rules, an operating agreement allows customization and more detail to better suit their business (operating agreements can’t go against government laws) - say you know taxes are due April 15 by law, but you want to outline who will do business taxes, when they will be started, how you’ll track expenses; that can all be outlined in an operating agreement.
Referenceable document that can be updated as your business changes or you decide to sell - if you add another member or manager to the business, you can use this document as a starting point for how things will change.
Provides a layer of legal protection for the members onced signed as the document becomes legally binding - say it comes time to distribute profits and your partner thinks they deserve more than you and they sue you, you can reference the operating agreement in court for quicker resolution.
A well-crafted operating agreement can enhance the credibility of the business when dealing with banks and potential investors, it shows that the business is professionally managed and has clear rules.
How to Draft an Operating Agreement
An operating agreement isn’t typically required by law in most states and can be as formal and informal as you want, below are three suggestions based on what you’re looking for:
Unstructured
Nick and I started with an unstructured operating agreement - like really unstructured, we went out to eat and wrote our thoughts on a napkin. The conversation was helpful and we wrote down some key clarifications on how we wanted to operate our business.
You can do something similar and write it down on a piece of paper or document your thoughts in a word doc and upload it to your Google Drive.
Structured, but informal
Nothing was wrong with our napkin operating agreement, but we didn’t know if we were missing anything, so we used LawDepot to complete a free operating agreement. We liked it because it asked you simple questions and generated an operating agreement personalized to your state.
Structured and formal
You can also hire a lawyer to help you draft one, but this comes with a large cost. An agreement created with the help of a lawyer is more likely to be comprehensive, precise, and tailored to ensure that all legal bases are covered, thus providing greater protection and peace of mind.
An operating agreement is something that you should keep in your documents - reference post 2.1 to see where we would upload it.
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