Why You Need an Operating Agreement

If you have an LLC and your company has more than one owner, you need an operating agreement. Period.

An operating agreement is a contract between the owners of a business that tells them how they’re going to run their business. Think of it as the owners’ rule book and prenuptial agreement. It puts everyone on the same page from the beginning in terms of what each person owns, what each person is responsible for, and how you’re going to resolve problems.

Your operating agreement can answer important questions like:

• If an owner wants out, how much notice does he have to give? Do the other owners have first dibs on buying his portion of the company?
• Do owners ever have to contribute their own money to the business?
• What do you do if an owner isn’t pulling her weight? Can she be voted out of the company?
• How will disputes be settled? If there’s an even number of owners with equal votes on each side, what’s the tie-breaker?
• What happens if an owner dies?

Don’t think that you don’t have to create an operating agreement if you’re going into business with your best friend, spouse, or relative. We all know someone who has gone through a nasty divorce. The same can happen in the break up of a business if there isn’t an operating agreement that tells you how events will proceed.

It may seem strange to think about how you’ll handle problems at the beginning of the business, but it’s the ideal time to put these provisions into place. Hopefully everyone is optimistic and thinking about the business’ best interests which will make it easier to decide the best way to handle major decisions down the road. If you put off figuring out how you’ll resolve disputes until one occurs, you’ll be fighting over how the company should resolve its problems and you’ll be fighting over the problem at hand.

Operating agreements aren’t just about resolving problems. They give you the ability to create the company you want. Some companies may decide disputes in mediation, but you can choose to settle problems with a coin flip, a game of ping pong, or let your dog decide if that’s what you and the other owners want. You can also use your operating agreement to declare other rules like requiring everyone to bring pie to work on March 14th (Pi Day) and allowing video games as an acceptable brainstorming technique.

You’re not required to have an operating agreement if your LLC is in Arizona, but you’re asking for trouble if you don’t. This is one of those times when it’s worth it to pay a lawyer. You will pay a lot less to have someone draft the agreement for you, than to clean up the mess that could result when you and the other owners have a major dispute and everything goes to hell.