Why Your Partnership Needs an Operating Agreement
By: Attorney Nicole Hetz
Are you thinking about partnering with someone to start and build a business?
Let me stop you right there! You 100% need a Partnership Operating Agreement. The first stage of a partnership can feel a lot like a honeymoon: things run smoothly and everyone is committed to the business. The speculative things seem easy-peasy and oh, they’re scary but you’ll just figure them out. But, what happens when things get difficult or you run into some conflicts with your partner? You should be able to find all the answers to these situations in a partnership operating agreement. That is, if you have one! Every LLC needs an operating agreement specially if multiple partners are involved in the operation.
A partnership operating agreement is one of the most important pieces of documentation you need when forming a partnership, no matter what type of partnership you are choosing to be: a general partnership, limited partnership or limited liability partnership. Before we move on, it’s important to define the difference between these types of partnerships. A general partnership is a business with two or more partners, both sharing the same or almost the same amount of liability. In a limited partnership, at least one of the owners is considered a "general" partner who makes business decisions and is personally liable for business debts and at least one of the owners is considered a "limited" partner. The limited partner (whether or not they have a consulting role or no role), can only lose the amount they have invested in the business. Meaning, if the business does well, they can make money from it. If the business does poorly, needs to shut, or has owed debts or liabilities, the limited partner would only be liable for the amount given, no more. On the other hand, a Limited Liability Partnership (LLP) is a similar business structure but it has no general partners. All of the owners of an LLP have limited personal liability for business debts. This entity type is normally used by professionals such as accountants and lawyers.
When building the operating agreement, the partners should reflect on their individual skills and expertise and establish a division of labor. This is necessary because you want to avoid confusion and conflict between partners. Now is the time to have those difficult conversations and set out how business decisions will be made and how you will manage the day to day demands. At the same time, this agreement will be the reflection of how your company is run and will be the document that you present to banks or investors to show you are serious about your business.
Besides your standard provisions for an operating agreement such as purposes and powers, roles and responsibilities of partners (ie. will they help with day to day operations or just be there occasionally to consult), capital contributions and distributions, death, disability and dissolution, you need to think beyond. Ask yourself: What should I include in my agreement? You are the master of your own business and you are the one who knows best what type of circumstances should be covered in your agreement.
Lastly, let’s address the elephant in the room: How do I get out of this partnership? This is the hardest part of the agreement because you are just starting a business, how could you think about ways of ending it? Don’t be surprised but this is the most common question we receive from our clients. The best solution here is to establish a few possibilities where one partner can buy the other partner’s interest before others can buy it or what we call right of first refusal. You can also establish certain provisions that would trigger the sale of that interest or membership units, for example, if one of the partners does something that damages their reputation and as a consequence, affects the company’s reputation.
If you need Partnership Operating Agreement legal services such as reviewing, drafting, negotiating, or revising, please reach out for a 30 minute, no cost service consultation. Our team of experts can help you with your business law needs and help set you and your partner (if you have one or several) up for success. Get in touch with us.