Operating Agreements Are Critical to Your New Business
Your idea for a new business nagged you for years, and now you’re finally ready to pursue it. You’ve engaged some partners, identified financing (or dipped into savings), explored the market, and even found some promising leads for early customers.
At this point we, as lawyers, want to remind you:
Don’t forget the paperwork – and take it seriously!
We recommend forming a limited liability company (LLC) – or a corporation – to protect your personal assets from any lawsuits affecting, and debts of, your new venture, and to set yourself up for success. NOTE: While this post focuses on operating agreements for LLCs, similar considerations apply for bylaws and shareholder agreements for corporations.
We’ve repeatedly seen first-hand that spending a little time and money now to draft an operating agreement outlining how partners will operate the business and make critical decisions can save you a lot more time – and definitely more money – later.
Granted, if you’re going to own 100% of the enterprise, the operating agreement can be pretty simple. You may not need much legal help in submitting the proper documents to the Secretary of State or opening a separate bank account for your establishment. And while you don’t need an operating agreement ordering you to have meetings with yourself once a month, following formalities, like adopting and following a proper operating agreement, helps prevent courts from letting litigants and creditors “look through” your company and impose personal liability on you for the company’s actions and debts.
And for any group of partners starting a new business, proper governing documents are critical. Without them, for example, disputes over decision-making, profit-sharing, or company strategy can lead to expensive litigation for everyone.
Even when an LLC has an operating agreement with a process for decision-making, we’ve seen two partners try to improperly push out a third. What saved the third partner was that the first two partners didn’t follow their operating agreement’s process for removing a partner, so the third partner was able to have the situation reversed.
What’s the lesson here?
Operating agreements protect all of the partners.
Less dramatically, but no less important, imagine an operating agreement that says the company will buy out any partner who wants to leave the business. In some ways, that makes sense, but what happens when four out of 10 partners want to leave at the same time? Paying all those buy-outs all at once could ruin the company. The company may be able to negotiate payment plans, but that can be hard when the departures are causing emotions to run hot, and the company would be better off with an operating agreement that guides the company through a larger exodus of partners.
This kind of specific detail reflecting the realities of a particular type of business shows the limits of the “one-size-fits-all” operating agreements one might obtain on the internet. Real-life lawyers ask thoughtful questions of their clients to help them think through the hard situations a new company may face in the future. We help clients prepare agreements addressing how they want to resolve day-to-day disputes (perhaps a 2-1 vote prevails) and how major decisions should be made (maybe unanimously).
Operating agreements also establish partners’ expectations of each other, which is especially important when partners are contributing different things to the company. Some may be contributing money and others sweat equity. Describing how these contributions are recognized upfront helps avoid disputes down the road.
We’ve seen repeatedly that it’s better for partners to hash out their differences now, when they are getting started, rather than during a situation when tensions could be high.
To be sure, we understand you are fighting an uphill battle just getting your business going. It’s a busy, exciting, and optimistic phase, and you don’t want to spend time talking with an attorney about worst-case scenarios. But if you think a few hours with an attorney now is costly and annoying, imagine how you’ll feel if you don’t have proper agreements in place to protect you when disputes get litigious, and you start wasting time and money in depositions, court hearings, and trials. Do yourself a favor and set yourself up for success!
Sarah H. Abbott is a business, regulatory, and real estate attorney in Ireland Stapleton’s Grand Junction office.
Mamie Ling is a litigation attorney in Denver representing clients in retail and hospitality, real estate, construction, transportation, and public entities in matters involving contractual disputes, products liability, construction defect, governmental immunity, and premises liability.
David S. Manush of the Denver office focuses on construction law and professional liability matters, in which he advises and defends architects, engineers, and other construction professionals in all areas of litigation in state and federal court.
What is written here is for general information only and should not be taken as legal advice. If legal advice is needed, please consult an attorney.