Oct25
Setting up an Operating Agreement
- posted by: George
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Well after being in business for 8 years we’ve decided to setup an operating agreement. It’s usually one of the first things you setup in a partnership / LLC; however the three of us decided to put this off to a later date in favor of using our funds to start the business. A few months turned into a few years and we finally just started the process.
For anyone who hasn’t setup an Operating Agreement before I suggest having some whiskey while working out the details. I say this because you have to work through all the ugly factors of what it looks like if you or your partners get disabled, dies, gets divorced, is forced to buy-out their share, or someone commits a moral turpitude (yeah, that’s a new word for me as well). Most importantly you’ll have to decide on the valuation of the company. Given that we never intend to sell the company or shares of it, this is one of those items we neglected to address for many years. In most cases valuation is arbitrary until you try selling the company; however it does play a part in the structure of the Operating Agreement. Knowing your valuation will help you plan for things like a forced buy-out or disability.
In our case we determined valuation by using a weighted average of 3 times our net profits for 2010 (current year), 2 times net profits in 2009 and the net profit of 2008 divided by 6. Then we applied an arbitrary factor to this number (for us it was 2) until we arrived at a number we liked and felt it would adjust nicely as we grew. As of October 2010 that value is $900k. This number is highly subjective to the owners’ goals for the company. For us, the valuation is low because we want to discourage the owners from selling their share to third parties. Additionally, if something happens to one of the three owners, Imulus will have to buy-out the other owner’s share, so in this scenario Imulus benefits from a low valuation. However, this doesn’t benefit the families of the deceased owner. Paying off the paltry sum of $300k to an ex-owner’s family likely isn’t going to replace the income of the deceased owner over a lifetime. That’s what life insurance is for.
It’s topics like this that you’ll have to address. Many of these topics are simply avoided because of the subject, yet if they are never discussed openly and addressed; then when something happens your company will be in a world of hurt. In hindsight, we’ve been driving over the speed limit without a seat-belt for the last 8 years – this was a reckless thing to do. If you are running a company without an Operating Agreement, I’d suggest looking into setting it up sooner rather then later. Start reading up on the topic over at NOLO and familiarizing yourself with how it all works.
Feel free to shoot any questions my way. I’d be glad to answer them based on my experience with the process.
