3 Tips for Structuring an Operating Agreement for Your Business

Matt with EWA. Today we are talking about a few tips on how to structure an operating agreement. So typically an operating agreement goes into effect when a partnership or a multi member or multi manager firm gets set up.

There are several very important tips to follow here to make sure that the business is protected and thriving even when there’s internal conflict. Studies have shown that over 60% of mergers or acquisitions end up being value destroying instead of value creation.

So an operating agreement can not only protect you, but it can help you get through a really bad situation, a really bad partnership. There are many factors and many considerations and would recommend to hire a very good legal counsel to help structure and monitor the operating agreement ongoing.

But we’ve narrowed it down from experience with our business owner clients and internally on our top tips. First and foremost is the who. So most operating agreements will have either managers who are typically the real decision makers and then members who have equity but maybe do not have as much of a decision making process in place.

So defining who is in the operating agreement, who has equity versus who is an employee or team member who would not have anything to do with the operating agreement on top of determining the who is the percentages of financial interest and then typically who has voting rights and who does not voting rights.

And depending on the type of corporation you have, you can have non voting and voting rights and these can be the same as the financial percentages or different than the financial interest. So for example, someone could have 51% of a company and have.

Not only financially 51% but also have 51% voting rights. So the majority of the decisions, unless otherwise described in the operating agreement would be at the sole discretion of the person that’s 51% or greater.

There can be a delineation where someone has 51% financial interest and then does not have full voting right and would need the agreement of other managers or members before making big decisions. Our second tip is define very clearly how decisions are made.

So oftentimes a business needs very quick and decisive action for the business to stay afloat and stay on top ahead of competitors. So if an operating agreement requires every single person involved to unanimously decide, the business could be crippled and not be able to make decisions quickly because of disagreement.

So typically the sole manager, the person that has the majority of the company should be able to make the majority of decisions at the sole discretion and then notify the other members. But some operating agreements on big decisions.

We’ve seen that someone could have the majority interest in the company not only the voting but also the financial interest. But that some decisions for example such as if there’s going to be a membership interest transfer for example an equity member that has 10% getting voted down to 5% this could either be unanimous vote or greater than 65%.

So that person that had that 51% interest would need someone in addition of 14% or greater to be able to make those kind of changes. We often can see this also for capital calls. So if there’s a requirement for equity members to put more additional money to keep the business afloat, that this needs to be more than one person deciding or for purchases that are very large.

So for example, if a business has a couple of million dollars of revenue. And a new technology or new purchases being purchased, let’s say for over 100,000. This is not at the sole discretion of one person.

It also has to be put to vote. So there can be a delineation where certain decisions that are big to a business can be put to vote versus normal day to day business operations, maybe at the sole discretion of one person.

This has to be clearly defined in the operating agreement so that when conflict arrives, not if, but when, it does completely normal that there’s a clear pathway to success. On top of determining the who is the percentages of financial interest and then typically who has voting rights and who does not have voting rights.

And depending on the type of corporation you have, you can have non voting and voting rights and these can be the same as the financial percentages or different than the financial interest. So for example, someone could have 51% of a company and have not only financially 51%, but also have 51% voting rights.

So the majority of the decisions, unless otherwise described in the operating agreement would be at the sole discretion of the person that’s 51% or greater. There can be a delineation where someone has 51% financial interest and then does not have full voting right and would need the agreement of other managers and members before making big decisions.

An operating agreement. Please reach out if you have any questions.