How to Draft an Operating Agreement for Your Small Business

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Have you ever sat down and drafted an operating agreement for your small business? Despite the fact that an operating agreement is considered one of the most important documents an LLC can keep under its belt for structuring a company, many people skip over it. Depending on where you live, it may not even be a written requirement for your business. Clocking in at anywhere from 5 to 20 pages in length with only a vague idea of what the content written should even be about, many businesses choose to omit working on one.

For any business owner, however, it is in their best interest to create a written operating agreement for their LLC, regardless of whether it’s a state requirement or not. According to the U.S. Small Business Administration (SBA), the operating agreement works to protect the business, governs the internal operations of the business to suit the needs of its owners, and helps to prevent any financial, verbal and management disputes along the way. Once signed by its members, the operating agreement serves as an official contract binding them to the items agreed upon. Before you sign off on an operating agreement, it’s important to know what needs to go into the draft. If you are ready to develop one make sure that your agreement outlines the following areas:

1) Percentage of members’ ownership.

These percentages tend to be in proportion to the investment capital given to the LLC. The more capital a party puts into the LLC, the higher that party’s ownership percentage is in the company. LLCs may also distribute ownership percentages on their own terms such as making a women or minority at 51 percent owner for a strategic reason. You can do whatever you want; you will just need to specify the ownership percentages.

2) Voting rights and responsibilities.

In the event that members of the company disagree over a particular business decision or cannot come to an agreement over a controversy, specifying the voting rights of every member works to help resolve these issues as quickly as possible. Generally, ownership percentages determine voting percentages, but LLCs may allocate equal voting rights to all their members. Additionally within this section of the operating agreement, it’s important to include any tie-breaker mechanism too.

3) Powers and duties of members and managers.

All expectations of the members and managers in which the LLC will be governed must be specified.

4) Distribution of profits and losses.

In addition to specifying the LLC’s mechanism for distributing shares of the company, the operating agreement needs to specify the conditions for distributing the actual profits and losses to its members. Answering the questions upfront on how much and how often these profits and losses will be distributed to the members, could save headaches in the future. There are also tax implications for these decisions.

5) Ownership transitions

This will help specify the procedure for how the ownership of the LLC can be transferred with buyout and buy-sell rules in place. Transitions addressed may include discussion on what happens if a member dies or no longer has the capacity to be a member. You’ll want to spell out if the LLC should have the first opportunity to buy-out a member’s ownership interest, and/or if a member is free to transfer their interest to any other party.

6) Dissolution of the LLC

Finally, the operating agreement needs to specify under what conditions an LLC will be dissolved and liquidated if necessary.

While taking valuable time away from running and growing your business may seem impossible, setting aside time to think through and then draft a detailed operating agreement will prove extremely valuable to business owners and partners. Drafting an operating agreement for an LLC can be likened to drafting a will. Many people drag their feet about doing it, but the implications of not doing it are significant. Once the operating agreement is finalized, it may only take a few hours to get down the primary points. Drafting an operating agreement, will give you piece of mind knowing that there is a solid management plan in order. Going into business with a clear understanding with your business partners is the best way to start and end a business relationship.

Author Bio: Deborah Sweeney is the CEO of MyCorporation.com, a leader in online legal filing services for entrepreneurs and businesses, providing start-up bundles that include corporation and LLC formation, DBA, and trademark & copyright filing services.