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Do Family Businesses Need an Operating Agreement?

By Christopher Coble, Esq. | Last updated on

Part of the appeal of a family business is the family part, as opposed to the business part. Having a warmer, more informal relationship between the owners and employees stands in stark contrast to the calculating, profit-driven world of LLCs. Plus, why share profits with stockholders when you can keep all that money in-house, as it were?

Then again, we all know how families are. There is the ideal of the "Mom and Pop Shop," and then there is the cold reality of succession plans and sibling rivalries, where the fantasy of a happy family business often gives way to the realities of family and financial strife. So how do you make sure your family business weathers those storms? With a good operating agreement.

What an Operating Agreement Is

Long before your small business opened its doors to the public, you had a plan, an idea of what the business was designed to do and where it was designed to go. The plan often includes whose responsibilities are whose, who has what kind of stake in the company, who gets what percentage of the profits, and what happens to if an owner leaves.

The problem is that as your business goes from small to large, or from small to smaller, it's easy to continually change that plan or lose sight of it completely. An operating agreement is basically this plan put to writing before a small business is born. The operating agreement will lay out each co-owner's percentage ownership share of the business, each owner's share of profits (or losses), the rights and responsibilities of the owners, and what will happen to the small business if one of the owners leaves.

What an Operating Agreement Can Do

The biggest advantages to having an operating agreement are its ability to avoid confusion and conflict. When everyone is on the same page, there's less arguing about the content of the page or what will happen when the page is turned. To avoid turning your family business into a family feud, you can make sure an operating agreement:

  • Lays out the profit- (and loss-) sharing breakdown between all of the owners and employees;
  • Clearly defines the managerial structure and procedures for decision making about the business; and
  • Provides for a succession plan, including buyout or buy-sell rules that govern when an owner's sale of an interest, or an owner's death or disability.

If you want to keep the "family" in family business, think about taking care of the business part first, so family can take care of each other later. Without any confusion about who's calling which shots, who's getting what share of the profits, and who's getting the business later, your family business can experience less conflict and enjoy more conviviality

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