Why an Operating Agreement is Essential for Startups


Everyone knows there is a mountain of red tape that needs to be dealt with when starting a new business. Not only do you need to register your business with the appropriate local, state and federal entities, get the requisite tax IDs, and meet other federal, state and local laws, but you need funding as well. However, this isn’t exactly all there is to launching a new business. There is one seemingly small detail which so many people are unaware of, and once you understand what this is, you’ll also understand why you can’t afford to ignore it!

Beyond a Business Plan

You have probably read much about that all-important business plan you’ll need to draw up, especially if you’ll need funding or financing. This is, in brief, a synopsis of how you will organize your business and how you expect to make a profit. Yes, a business plan is important, but so too is an operating agreement. Let’s take a closer look at why you need one.

What in the World Is an Operating Agreement?

Wondering what an operating agreement is? In effect, an operating agreement is an outline of how your business will be run and who gets what share of profits or owns what percentage of losses. It details who makes decisions and how they are made. As opposed to a business plan or model that indicates how profits will be made, an operating agreement outlines literally who does and gets what. For example, this agreement will detail how decisions are made and what will happen if someone steps outside the boundaries you’ve set. You can’t afford to ignore this advice because the purpose of an operating agreement is to safeguard your business from a number of lawsuits and legal entanglements.

How an Operating Agreement Safeguards Your Business

Let’s look at a quick example of why you need an operating agreement. Say you start a business with two other partners. An operating agreement defines how decisions will be made. Do you need a majority vote, or is there a senior member who speaks for the whole? Does one partner handle the financial decisions while another is in charge of creatives, leaving the third to deal with hiring and all things HR? If one partner steps into the realm of another partner, what will the repercussions be? Also, an operating agreement defines how the business would be divided or who gets the shares of one member who passes away.

In order to avoid lengthy and costly litigation in a court of law, an operating agreement is an absolute must. If you haven’t already agreed on one, now is the time to do it. This goes beyond what a business plan details and could save a lot of headaches going forward. Obviously, it would be best to create an agreement before launching your new business, but if you haven’t, get on it immediately. This really is practical advice you cannot afford to ignore, and now you understand why. Save your business from legal entanglements by outlining how your business will be run and shared.