When multiple people go into business together, a written Operating Agreement is the ultimate roadmap. A comprehensive, customized agreement prevents operational standoffs, protects your financial interests, and provides a structured mechanism to resolve disagreements without resorting to costly litigation.
Generic operating agreement templates often gloss over the tough operational details. When real money, control, and different personalities are involved, these gaps can bring a thriving business to a grinding halt.
To protect your business and prevent expensive internal conflicts, here are the 10 most important provisions to include in your operating agreement:
- Clear Management and Decision-Making Structure
Your agreement must explicitly state whether the company is member-managed (all owners have a say in day-to-day operations) or manager-managed (members appoint specific individuals to run the company). It should clearly outline the scope of the managers’ authority, and list the major actions that require a supermajority or unanimous vote (e.g., taking on significant debt, selling core assets, or amending the agreement itself).
- Capital Contributions and Capital Calls
Disputes frequently arise when a business needs more funding, but owners cannot agree on who pays. The agreement must detail the initial financial contributions of each member and outline the procedures for future capital calls. It should strictly define what happens if a member cannot or will not meet a capital call—such as diluting their ownership percentage or treating the unfulfilled contribution as a loan.
- Profit Allocations and Distribution Schedules
Money is often the root of all partnership disputes. Your operating agreement needs to clearly state how profits and losses are shared and whether distributions are tied exactly to ownership percentages or determined by other criteria. It should also establish when distributions are made (e.g., quarterly or annually) and how to handle necessary cash reserves for the business’s operational needs.
- Deadlock-Breaking Mechanisms
What happens when two 50/50 owners cannot agree on a critical business decision, or a vote ends in a tie? A deadlock provision prevents the business from freezing. Mechanisms for resolving deadlocks include bringing in an outside neutral tie-breaker, initiating a structured buyout, or—as a last resort—mandating the dissolution and wind-up of the company.
- Transfer Restrictions and Rights of First Refusal (ROFR)
Without clear rules, an owner could sell their membership interest to a difficult stranger, or an unexpected inheritance could introduce an uninvolved family member to the cap table. Include transfer restrictions that require unanimous or majority member consent for new owners. A Right of First Refusal (ROFR) ensures that if a member wants to sell, the company or remaining members get the first option to buy out the shares at the same price offered by an outside party.
- Comprehensive Buy-Sell Provisions
A buy-sell agreement acts as a prenuptial agreement for your business. It dictates exactly what happens to a member’s interest upon a triggering event, such as retirement, death, divorce, bankruptcy, or termination of employment. It should establish a precise valuation methodology (e.g., agreed-upon value, formula, or third-party appraisal) to ensure a fair buyout process.
- Member Duties, Non-Compete, and Fiduciary Obligations
In closely held businesses, a departing owner could easily poach clients or start a directly competing business. Your agreement should clearly define the fiduciary duties of loyalty and care. It can also include restrictive covenants—such as non-compete, non-solicitation, and confidentiality clauses—to protect the company’s goodwill and intellectual property.
- Clear Dispute Resolution Procedures
No matter how well-drafted the agreement is, disagreements will still occur. Rather than heading straight to an expensive, public courtroom battle, outline an escalating dispute resolution process. This can require good-faith negotiations, followed by mandatory mediation before any party is permitted to initiate formal arbitration or litigation.
- Shotgun and Drag-Along Provisions
When members reach an absolute operational impasse, or when a majority owner wants to sell the entire company, these exit provisions are essential.
- A Shotgun Clause allows one member to offer to buy out another member at a specific price. The receiving member must either accept the offer and sell their shares, or turn around and buy out the offering member at that exact same price per share. This prevents lowball offers.
- A Drag-Along Right ensures that if a majority of members want to sell the company to an outside buyer, they can force (“drag”) the minority members to join the sale on the same terms, preventing a single disgruntled minority owner from tanking a lucrative acquisition.
- Dissolution and Exit Strategy
Every business partnership will eventually come to an end, whether by choice or by necessity. A solid operating agreement must outline the orderly wind-down process for dissolution. This includes the steps for liquidating assets, settling liabilities with creditors, and a priority list for making final distributions to the members.
If you need highly experienced legal counsel to assist with entity formation and drafting of all the provisions listed above, and many more, you should contact Belenky Law Firm PLLC as soon as possible, and don’t make the mistake of going at it alone or with a cheap foreign attorney who does not understand how state laws or the above provisions truly work in a precarious situation. You don’t want to lose your investment fighting members in court for years.