Imagine this scenario:
A couple of years ago you partnered up with a few associates and started a new restaurant business. Because you did not know much about the business, you opted to take a background role, with your contribution largely being financial. You trusted your partners, who had experience as chefs and restaurant managers, to run the day-to-day operations of the business. After a few rough months, the restaurant started doing really well and is now thriving, but you have not really seen much in the way of a return on your investment.
You have started to wonder and have asked your partners whether you will start seeing some distributions any time soon. You also called a local lawyer you know who has experience with small businesses and asked her for some advice. You and she scheduled a meeting, and she asks you to bring a copy of the company’s operating or partnership agreement. You check your files and review your emails from a few years back only to discover there is no such agreement, that you and your partners never entered into one. You were too excited to get going and didn’t want to spoil the good vibes between you all.
You mention this all to the lawyer when you meet with her, and explain the overall situation, before asking her, “What are my rights?” Her answer (not in so many words, and perhaps a bit more gently): “Who the heck knows?”
While it is true that the corporate and business law of the state you live in may provide some answers, the lesson of this imaginary story is this: It is impossible to overstate how important a good operating agreement** is if you are embarking on a restaurant (or any business) venture with anyone other than just yourself. With the possible exception of your restaurant lease, it is probably the most important document you will deal with. That is because, while your lease may be a key factor in whether you succeed or not, your operating agreement will be the determining factor of what happens if you succeed or not. And, as I tell my clients, sometimes the worst thing that can happen if you do not have a good operating agreement is that you do succeed, because then there is actually something worth fighting over.
So, why do you need an operating agreement? It is, among other things, to answer the most critical questions about how your company will be run:
- Who has primary responsibility for managing the day-to-day affairs of the company?
- What are the manager’s duties, obligations, and responsibilities?
- Which matters get put to a vote of the members and which are left to the discretion of the managers?
- What happens if the manager of the business is failing in his duties and needs to be removed?
- How are profits of the business distributed to the members?
- What happens if a member of the company wants to leave and be bought out?
- How does the company raise more money if it is needed?
- What if the company wants to take on investors as new members?
- What happens if the company gets purchased?
- What happens if the business fails?
The time to get on the same page with your business associates regarding these questions is at the start of the business, not when they come up later on. Because if you wait until then, and you do not have a good operating agreement, the answer to each of these questions can be the same as the one the lawyer gave in the story above: “Who the heck knows?”
** NOTE: I’ve used the terms “operating agreement” and “members” in this post because most of my clients structure their businesses as limited liability companies (LLCs), but the same would be true of a partnership or shareholder agreement if you were structured a partnership or close corporation.