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The AR Group

The Importance of an Operating or Partnership Agreement

By Julie Morris

Forming a Limited Liability Company (LLC) or Partnership can be a very attractive option if you’re looking for a business structure with less formalities. In fact, most states don?t even require an LLC to file an Operating Agreement, or a Partnership to file its Partnership Agreement. (Note that the kind of Partnership contemplated in this discussion is a Limited Liability Partnership because a General Partnership results in personal liability of the Partners for debts of, or claims against, the Partnership).

Time and again clients come to us with issues following a business partner dispute. The first question we ask is whether a written agreement is in place. All too often, the answer is, no. Consequently, the steps toward resolution are more complex and uncertain, and usually more costly, than they would have been if an effective written agreement had been in place.

We understand and believe that business partnerships, like marriages, are generally entered into with a fundamental belief that because they are relationships built on mutual trust, respect, and confidence, they will stand the tests of trials, tribulations, and time.? Unfortunately, however, not all partnerships succeed, and the truth is that when business partners are close friends or relatives, the aftermath of a dispute can be much worse than if the relationship were born strictly from a business relationship. What we know from experience is that when individuals take the time, in advance, to carefully and methodically consider the scope of their business relationship and commit the terms of that relationship to writing, the probability of both success in continuation and in dissolution is enhanced. Regardless of the business structure, a properly drafted Agreement at a minimum should:

1) Clarify Verbal Agreements: Business owners often rely on verbally agreed-to terms in order to conduct day-to-day business activities. This practice will invariably result in misunderstandings as questions arise with no foundation to turn to for guidance. It is a best practice to have key understandings of your business relationship committed to writing so they can be referred to when conflicts or misunderstandings arise.

2) Override State Default Rules: Each state generally has basic governance rules for LLCs and Partnerships, and those state statutes will govern your business unless your Agreement states otherwise (these are called ?default rules?). By having an Agreement in place, you can decide the rules that will govern your business? inner workings, rather than having to follow state default rules that may or may not be right for your business.

Defaulting to state law for important decisions could jeopardize your business, its owners and the business it conducts. Moreover, it can make things more complicated for owners, particularly if you resort to looking up state statues just to make business decisions. If you don?t want the state to tell you how to run your business, it?s important that you have a well drafted Agreement that is personalized to fit your needs.

3) Define Financial and Management Structure: In most cases, business owners choose either an LLC or Partnership structure with flexibility in mind. However, that flexibility can be lost if the operational structure of the business is not well defined. Therefore, in the Agreement, the owners will be provided with a clear set of agreed upon terms, greatly reducing the likelihood of disagreement in the future. As a general rule, at a minimum, all business owners should include in their agreements:

  • Percentage of ownership with capital contributions
  • Voting rights and responsibilities
  • Conflict resolution
  • Powers and duties of owners
  • Rules of management
  • Distribution of profits and losses
  • Rules for holding meetings
  • Admitting and removing owners
  • Buyout and buy-sell rules

Smart Tip: There is no ?one size fits all? template for an operating or partnership agreement. These Agreements range from simple 50/50 arrangements between two individuals to complex structures with multiple classes of ownership. Notably, as businesses grow, complexities often arise and Agreements may become obsolete. Owners should not only be aware of the provisions within the agreement, but whether they are still relevant.