Entrepreneurs: Do You Understand the Importance of an Operating Agreement?

By January 20, 2022 April 24th, 2023 Small Business Planning

Last Updated on April 24, 2023 by Dave Schoenbeck

Many small business owners, especially entrepreneurs new to owning a business, fail to understand the importance of an operating agreement beforehand.  Clarity is essential for a family business or going into business with friends.

Close up view of male and female signing an operating agreement.

We assume that because we get along well with our business partners, we can avoid issues 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 a lot of resentment amongst your family and friends. 

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 assemble one, but today I want to impart the importance of an operating agreement.  Here’s what you need to know. 

What Is a Business Operating Agreement

A business operating agreement is a legal document outlining the main terms and conditions of managing the company.  For example, the contract includes who owns the company, who manages the company, how the company is structured, the company’s 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 discusses what happens in the event of dissolution.  Investors or buyers often demand an operating agreement before showing genuine interest in your business. 

Every type of business needs an 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 putting yours together. 

What Should Be in an Operating Agreement

Ultimately, an 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. 

An experienced business attorney can explain the importance 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: 

  • Organizational Structure.  This section will deal with the basics of the company’s creation, including its structure, who the leading players are, its purpose, and the story of its foundation. 
  • Member Roles and Duties.  It would help if you talked about each of your company’s key members’ roles, including listing yourself as the owner.  Include each person’s duties, contributions, and potential voting rights.  You should also touch on how to add or remove members if necessary.  A critical section is a specific process for making business decisions and disagreements about decisions and direction.
  • Financial Structures.  How will the profits be distributed?  Who will take on any losses you might encounter? 
  • Record-keeping. How will data be stored and managed?  Who will keep your books?  What methods will you use?
  • Dissolution.  No one wants to think about the dissolution of their company, but much like a prenup, this will help protect you when it happens.  No matter what the future holds, you want to be able to dissolve your business on your terms. 

If you still have questions, 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. 

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