Small Business Horror Story #7: Pre-Packaged Operating Agreements
Here’s what happens when you get your operating agreement from a legal forms company.
I just finished helping a client negotiate a buyout. In English, that means he and his partner stopped longer seeing eye to eye on how to run the business so the partner offered to buy my client’s shares in the company.
We spent a month negotiating and getting nowhere when the partner’s attorney proposed adding someone new to the company without my client’s permission. This type of thing normally doesn’t fly without at least a majority vote. Of course, these guys were 50/50 partners and were already hostile, so agreeing on something was not going to happen. I asked for a copy of the company’s operating agreement, which they had bought from a legal forms company.
A properly drafted operating agreement includes some restriction on how a new owner would be added to the company. Most operating agreements provide that a new member can’t be added without unanimous consent of the existing members. When I reviewed the operating agreement, I wanted to see something, ANYTHING, restricting the other partner from unilaterally adding someone to the company and further complicating already-complicated negotiations.
What did I find? Nothing. I found nothing.
Well, that isn’t exactly true. I found no restriction on adding new members. What I did find was an assignment clause, allowing either partner to assign part or all of his interest in the company to someone else anytime he wants. That’s even WORSE than having no restriction.
Flabbergasted, I read the rest of the agreement, which was 25 pages but had no real substance. Every section had generic language like “the members shall decide how to allocate profits and losses,” “the members shall decide how to add new members,” “the members shall decide how to dissolve the company.” Well, no s*** Sherlock. Of COURSE the members will decide those things. We didn’t need an operating agreement to tell us that. An operating agreement is supposed to provide guidance when the members DON’T agree, like NOW.
This is yet another reason why you should always have an operating agreement that’s been drafted by a lawyer. It may be expensive, but it’s even more expensive not to.