Great ideas are often turned into great businesses. Too often, however, the individuals who turn an idea into a business skip an important step – planning. Good business planning begins with discussions among the owners of a business and their professional advisors, including lawyers, accountants, insurance, and financial professionals. Once the issues are discussed and decided, the final product is memorialized in an “Operating Agreement” executed by all the owners.
Why Do I Need an Operating Agreement?
Owning a business is hard work. A business owner generally wants to build a successful, thriving business. But an important part of that business success is tied to good planning. As discussed more fully below, business owners must address important topics like what happens if they become incapacitated or pass away? Who will run the business when and if I retire? What happens if the owners have a dispute, how is that resolved? Good business planning is fact specific and will vary from business to business. Factors such as the type of business and complexity of its operations, the number of owners, each individual owner’s health, financial and family situation, and the complexity of startup activities will all have an impact on the planning process.
Some businesses have only one owner. Too often when a business has only one owner, the sole owner feels like business planning is not important. Even though a business may only have one owner, it is still important to go through the planning process in order to plan for and decide all the important items covered by an Operating Agreement. This becomes particularly relevant when a single owner becomes incapacitated or dies.
Much like when a person dies without a will, when business owners fail to plan, they are left with state law and, sometimes, litigation to fill in the blanks. Instead of relying exclusively on the default statutory rules, business owners should instead be proactive and go through the process of planning for the future success of the business and structure an agreement that meets the needs of the business owners.
Important Planning Considerations
Now that the business owners have decided to prepare and execute an Operating Agreement, there are several items that should be addressed in the Agreement, including:
Limited Liability
Employees, bank loans, customers, contractors, third parties and vendors are all sources of potential liabilities for a business. Shielding an owner from personal responsibility for business liabilities is one of the main reasons people create a business entity. But there can be limits to that shield and business formalities must be recognized and followed on a regular basis.
Ownership/In What Share
An Operating Agreement will confirm who the owners of the business are; what they have contributed to the business (cash, property, services, etc); and what each owner’s share is in the company. The Agreement will also address under what circumstances the business may add new owners or remove existing owners.
Management and Day-to-Day Operation
An Operating Agreement will address how a business will be managed. What role, if any, owners will take in the day-to-day operation of the business? Who will be responsible for what tasks and whether owners will be paid for their work in the business? If a dispute arises as to an important business decision, how that dispute is resolved should also be covered.
Super Majority/Unanimous Consent of Owners
An Operating Agreement will address important events that may require the approval of most or, perhaps sometimes all, the owners including executing major agreements, like a lease; taking out a loan; buying a major asset for the business; selling most or all business assets; hiring executive-level staff; adding new owners; and when to allow an owner to sell his/her ownership interests and under what terms.
Profits, Losses, and Additional Capital Contributions
An Operating Agreement will address how profits and losses are allocated among the owners and when distributions are made. Further, sometimes businesses need an additional infusion of cash. When, if ever, owners are required to supply additional capital should also be covered.
Everyday Life Events
When the owner of a business retires, goes bankrupt, gets divorced, becomes incapacitated, passes away, wants to sell, or wants to start a competing business – what happens? An Operating Agreement will address these common life events.
Conclusion
Remember, good business planning addresses tomorrow’s unknown. Although planning for the future can be intimidating, expensive, time consuming, and, at times, uncomfortable, business owners should not let that stop them from proper planning. Whether you are starting a new business or if you have already created a business entity and operated the business for many years with no agreement in place, it is never too late to review the business and create a plan. Nielsen Law PLLC provides family focused estate and business planning to individuals and families in Austin, Round Rock, Cedar Park, and the Central Texas area. For more information, and to learn about our firm, please contact us. We look forward to working with you.
