One of my biggest regrets from college is never taking any business courses. Now that I am producing a film independently, I’m learning everything as I go. Luckily I have a great line producer (Hi Taryn!) to hold my hand, and a great attorney, Nathan Workman, who can explain everything in laymen’s terms.
Recently Nathan has been working with Kelly and me to put together an operating agreement for Missy Movie, LLC. The process seemed intimidating at first, but it has been fairly simple, thanks to Nathan’s thorough and uncomplicated explanations. It seems not entirely unlikely that some of you may be in a similar situation, setting off on a grand artistic endeavor and unsure how to ground your project securely as a business. So I asked Nathan to enlighten us.
What is an Operating Agreement and Why is It Important?
Imagine playing in a basketball game with a State Championship at stake. How would you feel if the other team played with more than five players? Or if the referee kept extending the time of each period? Or if the number of points awarded for a basket kept changing? Even if you emerged victorious, it would wear you out mentally and cause a tremendous amount of unnecessary stress. The same is true for any business. Without a fixed set of rules under which to operate, things are constantly in flux, and there are no clear-cut guidelines under which to make decisions. For a Limited Liability Company, or “LLC,” the rules of the business are contained in a document called the Operating Agreement. It’s a contract, signed by all of the members (essentially, the owners) of the LLC, which lays out all of the important ground rules for running the business. If no Operating Agreement is put into place, when conflicts or problematic situations arise, state law will control the outcome, which may result in a much different outcome than you would want.
Do All Businesses Need an Operating Agreement?
I think it’s important that all businesses have a set of rules or guidelines which are approved by the owners. Operating Agreements are just a special type of document containing the rules of a particular business, and they are unique to LLCs. In corporate forms of businesses, like C Corporations, S Corporations, and Nonprofits, this document is called the “Bylaws.” In partnerships, this document is called the “Partnership Agreement.” They all have the same basic function, and they are all equally important.
How Does the Operating Agreement Relate to the Business Plan? Are They Usually Incorporated Together?
There isn’t a lot of interrelationship between the Operating Agreement and the Business Plan, in my opinion. Returning to the basketball analogy from earlier, the Operating Agreement is much like the actual rules of the game. A player doesn’t think of the rules constantly as he or she plays the game. Over years of practice, the rules are simply second nature, and the player acts in conformance with those rules as part of the game. The Business Plan is much like the team’s game plan. Within the confines of the rules, the game plan determines what the players must do in order to beat an opponent, and it changes from game to game. The better the execution, the greater the chance of success. Consequently, the Operating Agreement somewhat defines the parameters of the Business Plan, but it doesn’t provide a blueprint in itself of how to make the business a success. Also, since the Business Plan changes and evolves frequently, and the Operating Agreement typically doesn’t change at all, they are rarely directly incorporated together. There’s certainly no advantage to doing it that way.
How Much Do Operating Agreements Cost?
It all depends on what a business owner is looking for in an Operating Agreement. If he or she wants something extremely basic that simply states how profits and losses will be handled and provide basic guidelines for resolving conflicts, there are forms online which can do that. Legal Zoom and Incorporate.com come to mind as two major vendors of such agreements, and they run about $100. However, they aren’t providing any substantive value to the business. Most of these types of generic Operating Agreements simply mirror state law, so all you’re paying for is a false sense of security. Nearly always, the same legal outcome would occur whether or not you had a generic Operating Agreement. The real value in Operating Agreements is speaking with an attorney who understands your business model, identifies the risks involved with it, and has the knowledge and experience to minimize the exposure from those risks (or eliminate them altogether). Here, an ounce of prevention is worth a pound of cure. A good Operating Agreement will take an attorney between 4-5 hours of time in researching and drafting to complete. Based on that, a ballpark figure would be $600-1,000. If that seems high, keep in mind that most retainers for litigation are well over $5,000, so if the Operating Agreement prevents one lawsuit, it will have paid for itself many times over.
What’s the Most Important Element of an Operating Agreement?
The most important element of an Operating Agreement is the one that you’ve overlooked. It’s absolutely critical to have people with actual business or industry experience look over an Operating Agreement to ensure that all of the key issues are addressed. For instance, people will often leave out clauses or rules regarding confidentiality, intellectual property ownership, alternative dispute resolution, and numerous other topics. While an Operating Agreement can’t account for every potential scenario a business will encounter, it should account for every potential scenario that it likely will.
Nathan Workman is an attorney, writer, and entrepreneur located in Indian Trail, North Carolina. He is the Managing Attorney at the Law Office of Nathan Michael James Workman, PLLC, where he primarily focuses on Bankruptcy, Business Law, and Nonprofit Governance, serving clients throughout North Carolina and Florida. He can be reached at nathan@nmjw.com.
P.S. I linked to Nathan’s website at the top of the post, but here it is in case you missed it. Thanks for reading!
nmjw.com
-Alison
