Many small business owners, especially new entrepreneurs, need help understanding the importance of creating an operating agreement when first starting a business. Clarity on critical issues and procedures is essential, especially in a family business or when entering into business with friends.

We assume that because we get along well with our business partners, we can avoid the obstacles that usually sink a business. Unfortunately, this could not be further from the truth. A business operating agreement is like a will—you might not like to think about it, but if you don’t have one, you’re setting yourself up for future resentment amongst your business partners.

Much like a will, if you don’t have an operating agreement, you might be at the whim of state laws regarding how your business will be managed if a conflict arises. Of course, you’ll need a lawyer to help you draft one, but today I want to emphasize the importance of an operating agreement. Here’s what you need to know.

What Is a Business Operating Agreement?

A small business operating agreement is a legal document that outlines the key terms and conditions for managing a company. The contract includes who owns and operates the company, its structure, its finances, and more.

In addition to being required by law for many types of business, an operating agreement protects your assets from liability and documents all management policies. It also discusses what happens in the event of dissolution. Investors or buyers often demand an operating agreement before showing genuine interest in your business.

Every organization needs a business operating agreement, including family businesses, sole proprietorships, LLCs, partnerships, joint ventures, and strategic alliances. Once you understand the importance of an operating agreement, you should know what to expect when drafting one.

How Do You Structure an Operating Agreement?

Ultimately, a small business operating agreement is in the best interest of everyone involved with a company. Even a sole proprietor can benefit from an operating agreement if their business grows and changes over time.  The overarching goal is to prevent ambiguity and misunderstanding.

But what should be in a business operating agreement? An experienced business attorney can explain the importance of each section and help you determine the precise wording. Each business will have slightly different needs. In general, you can expect an operating agreement to cover the following topics:

1. Introduction: The operating agreement should begin with an introductory section that explains its purpose and scope, and identifies all parties involved.
2. Formation: Next, include basic information such as the formation date, the business name, and the agreement terms.
3. Structure: This section will cover the basics of the company’s creation, including its structure, key players, purpose, and founding story.
4. Membership interests: Here, you can include the members and their ownership percentages, along with other pertinent information, such as buy-sell provisions, procedures for admitting new members, and, if desired, the process for transferring membership interests.
5. Member roles and duties: It’s a good idea to talk about each of your company’s key members’ roles, including listing yourself as the owner or partner. Include each person’s duties, contributions, and potential voting rights. You should also address how to add or remove members, if necessary. A critical section is a specific process for making business decisions, maintaining alignment,  and how to handle disagreements about decisions and direction.
6. Voting: What is the voting process? What are the requirements around meeting frequency and attendance? How will decisions be made when a consensus cannot be reached?
7. Capital contributions: Discuss the initial capital contributions for members and the procedure for additional contributions later.  In many cases, partners’ capital contributions differ, requiring a clear definition of how this should be handled.
8. Profits and losses: How will profits and losses be allocated among members? How will the finances be distributed? Who will take on any losses you might encounter? How will you manage cash flow, reinvestment, and long-term sustainability?
9. Distributions: Your business operating agreement should specify the timing and frequency of distributions, as well as the procedures for special distributions.
10. Dissolution: Discuss how assets will be distributed upon dissolution and what events could trigger a dissolution. No one wants to think about the dissolution of their company, but much like a prenup, this will help protect you if it happens. No matter what the future holds, you want to be able to dissolve your business on your terms.  Partner’s future significant life events require discussion and agreement on how this will be triggered.
11. Operations management: You can cover your business’s day-to-day operations and management responsibilities here. If necessary, include details like employment agreements and the process for appointing officers.
12. Record-keeping: How will data be stored and managed? Who will keep your books? What organizational methods will you use? What is the procedure for financial reporting? Who will have access to your records?
13. Disputes: Sometimes, disagreements among members can become contentious. Write up a procedure for resolving these disputes, whether that involves mediation, arbitration, or litigation. A frequent friction point is a misalignment in partner commitment levels over time, and understanding that early-stage businesses require stability, patience, and follow-through.
14. Amendments: If necessary, how will the business operating agreement be amended? Will unanimous consent or a majority vote be required?
15. Miscellaneous: This section would be for anything not previously covered in your business operating agreement.
16. Signatures: All members or managers must sign and date your business operating agreement.

Consulting with a qualified business attorney is highly recommended to ensure the operating agreement adequately addresses all relevant issues and provides the necessary protections for the members and managers. Each section of your business operating agreement should be carefully drafted and customized to fit the specific needs and circumstances of the LLC.

Regardless of your business’s size, crafting an airtight operating agreement is the best way to protect yourself, your members, and your organization’s future. Covering all your bases upfront will save you the headache of figuring out your next steps in the heat of a future crisis.

If you still have questions about your business operating agreement, a business coach can help you understand the importance of an operating agreement for your company. Please fill out my contact form for a complimentary video call to discuss how to get started. You can also click here to subscribe to my free weekly blog articles about entrepreneurship, business, and more.

Coach Dave