Operating Agreement Essentials: Avoiding 5 Common Mistakes for A Stronger Business Foundation
Operating agreements are the unsung heroes of business stability, providing the essential framework for company operations and dispute resolution. While entrepreneurs often emphasize ownership structures and management dynamics, the devil is in the details when it comes to securing the future success of a business.
In this blog, our goal is to shed light on common pitfalls and ambiguously defined clauses that could pose a threat to a company's long-term sustainability.
- Vague or Absent Exit Strategies: One of the most critical but frequently overlooked aspects of an operating agreement is the exit strategy. Whether due to disagreements, retirement, or unforeseen circumstances, business relationships might come to an end. Failing to clearly outline buyout mechanisms, valuation methods, or procedures for selling or transferring ownership stakes can lead to prolonged disputes and financial turmoil.
- Inadequate Decision-Making Protocols: Decisions are an inherent part of any business, and how they are made can significantly impact operations. Overlooking the establishment of clear decision-making protocols, such as voting thresholds or procedures for deadlock resolution, can result in operational paralysis during crucial moments. Defining decision-making processes ensures a smoother operation and prevents gridlock.
- Failure to Address Capital Contributions and Distributions: Operating agreements often outline the initial capital contributions of members, but changes in financial contributions over time are frequently overlooked. Failing to address how additional capital will be raised, and how profits or losses will be distributed, can lead to financial disparities among members, ultimately straining relationships and jeopardizing the company's financial health.
- Inadequate Non-Compete and Confidentiality Clauses: Protecting the company's interests beyond the immediate business relationship is often neglected. Absent or poorly drafted non-compete and confidentiality clauses can expose the business to potential intellectual property theft, unfair competition, and loss of key clients. Clearly defining the scope and duration of these clauses is essential for safeguarding the company's assets.
- Ignoring Dispute Resolution Mechanisms: Disputes are inevitable, but overlooking how they will be resolved can lead to costly litigation and damage business relationships. Including alternative dispute resolution mechanisms, such as mediation or arbitration, in the operating agreement can provide a more efficient and cost-effective means of resolving conflicts.
Crafting a robust operating agreement requires attention to detail and foresight. By addressing these often-overlooked pitfalls and clauses, businesses can establish a solid foundation for success, fostering a clear understanding among members and mitigating potential disputes. Lastly, remember that these documents aren’t simply one-and-done. Your operating agreement should be reviewed regularly and updated as the business evolves to ensure that the document remains a reliable guide for the company's operations and protects the interests of all involved parties.
If you're questioning the effectiveness of your operating agreement for both your business and personal needs, explore our Partner Aligned Offering for tailored solutions.
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DISCLOSURE: Jarrod Musick is an officer of Destiny Capital and Entrepreneur Aligned, a DBA of Destiny Capital. This article is for informational purposes only and should not be relied upon as a basis for your investment, business, or personal financial decisions. We recommend consulting with your wealth advisor, CPA/tax advisor and/or attorney, as applicable to your situation, prior to implementing any new tax, legal, or investment strategy. Advisory services provided by Destiny Capital Corporation, a Registered Investment Adviser.
Jarrod was born into financial planning and solving financial problems. With his financial advisor father Steve telling stories about finance around the dinner table from an early age, the idea that everyone has a different financial situation was always there. After an early professional career spent in nonprofit and government, Jarrod came back to his roots helping people plan and invest in 2011. Since then, he has worked with individual clients, led internal teams and ultimately became partner and the CEO of Destiny Capital in 2017. With a passion for helping entrepreneurs change the world, Jarrod ultimately oversaw the creation of Entrepreneur Aligned in 2020. With both Destiny Capital and Entrepreneur Aligned, Jarrod leads teams that help people live lives of abundance where money is simply a tool to let everyone be a positive force for the world around them. When he isn’t working with the talented teams for EA and DC you can find him chasing his twins, wily trout or a podium spot at an OCR race.