When you are considering a shared financial investment one of the concerns is always the legal/financial responsibilities and protections that apply to individual members. Even for seasoned investors, the process of creating and understanding the importance of having an Operating Agreement in place can be complex.
According to the Legal Information Institute at Cornell Law School an operating agreement is a, “Governing contract adopted by members of a Limited Liability Company (LLC). It may be used to regulate nearly all aspects of the LLC's affairs, including how the business is managed, how assets are used and how revenues are shared. An operating agreement will override any default rules presented by a state LLC statute, which controls in the absence of an operating agreement.”
"When going into business with friends and family it is even more important that the rules for how the business will be operating are clear, agreed to, and documented to protect these relationships."
Here we look at 5 common questions about operating agreements:
- Why is an operating agreement important when working in a small group LLC?
Simply put, it protects the business and protects the individual owners of the business.
An operating agreement is critical for establishing the guidelines for how the business will operate. By making certain all owners of the business are on the same page the operating agreement helps to remove ambiguity if/when issues arise.
When going into business with friends and family it is even more important that the rules for how the business will be operating are clear, agreed to, and documented to protect these relationships.
- When in the process of a group investing is it important to form an operating agreement?
As soon as you can! Establishing an operating agreement should be the second action item after properly filing for an LLC.
- What are some of the more important components that members are agreeing to in an operating agreement?
It provides guidelines regarding:
- How the business will be managed
- Ownership/equity of all members
- How voting will work with respect to making decisions that will impact the business
- The roles/responsibilities of the members
- How the profits/losses will be distributed
- How to add new members
- How exiting members will be handled
- Whose responsibility is it to create and review the operating agreement?
All equity holding members of the LLC should want to have an operating agreement established. However, the creation of the operating agreement and its specific terms are usually created by a member or a few members of the LLC and approved by all of the members.
TribeVest provides an operating agreement template that simplifies and automates the creation as part of the LLC creation process. However, it is recommended that all members of the LLC review the operating agreement with their individual legal professionals.
- What happens if a member of the LLC wants to leave the LLC?
Without an operating agreement, it will likely involve lawyers, hurt feelings, and damage to the business. With an operating agreement in place, the rules have been established and the options are spelled out for the exiting member and the remaining members. The process is much smoother, relationships are maintained, and the business is not negatively impacted.
The exciting part of real estate investment as a team is celebrating your deals and building a business together. Making sure that you are protected with the proper operating agreement makes these celebrations more worry-free.