An operating agreement (and other types of agreements between business partners, including shareholder agreements, partnership agreements and joint venture agreements) should govern how the business is to work. In particular, what are the agreements among the partners? What role will each partner have in the work, in the management, in the finances? Will any partner receive a salary? How much? Are partners entitled to a job? What fiduciary duties does each owe to the business? How will profits be distributed? What about losses? Will the partners have to invest more in the business if there is a shortfall? Will there be other employees? What happens if there is not enough business income to pay employees? What will the exit strategy/buyout be? Are the parties married to one another for any future business of the same type?
Many entrepreneurs have not even thought about these and other critical topics. This can be a recipe for future disagreements, or worse. Sometimes people go into a business in good faith, but they have different expectations about the business. If you are the primary financial backer, is your sweat equity partner expecting a salary from day one? If so, are you okay with funding the salary until the business generates substantial revenues?
Having litigated major and bitter disagreements between business partners, I have seen the ugly divorces of the business world. The infidelity. Desertion. Dishonesty. No one believes it will happen to them, but business partners lie, cheat and steal. They will fire you and freeze you out of your own business. They will expose the company to liability. They will become drug addicts or non-functioning alcoholics. They will hire their do-nothing son-in-law who drives you crazy. They will spend all the revenues on their own salary and salary of family members. The will start a competing business and try to take all the clients. They will exploit any ambiguities in an “off the shelf” operating agreement you got online. They will die, and their clueless spouse will become your business partner (a cross-sell agreement with life insurance is a topic for another day). Or you will die and they will take advantage of your spouse. All these bad things, and worse, happen. If these things are happening to you, get competent legal help asap.
Your best first defense against misunderstandings and misdeeds is a specifically tailored operating agreement. This doesn’t mean that you are defenseless without one or with a poor one. You still will have rights. But courts respect operating agreements, especially if they are negotiated and tailored to the business at issue. You hope that your operating agreement keeps you out of court, but if you have to litigate or arbitrate over your business, you will be in a much, much better position if you have a good one. The relatively small amount of time and money that you spend at the beginning of the business formation (or before significant disputes develop) is some insurance against spending that same money hundreds of times over in legal fees.
By Adam P. Whitney 617.338.7000