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Start Your Business Startup Basics

Does Your Startup Need an Operating Agreement?

Does Your Startup Need an Operating Agreement?
Credit: Rawpixel/Shutterstock

In September, a bitter, year-and-a-half-long lawsuit between the founders of Snapchat finally came to a close.

Business Insider reported that co-founder Reggie Brown, who came up with the concept for the timed photo-sharing app but wasn't given equity for his work, received a settlement from the two co-founders who ousted him from their startup.

Had the Snapchat team set up an operating agreement prior to launch, they might have been able to avoid this costly legal snafu. Tricia Meyer, founder and managing attorney of business legal services firm Meyer Law, said that every entrepreneur entering a business partnership should consider creating one, too.

"An operating agreement is an agreement between owners in an LLC," Meyer told Business News Daily. "Think of it as a prenup for your business. It governs the internal affairs of the business and provides a framework around various business, financial and functional issues. Talking with your partner and deciding how you will handle certain situations while you're on the same page at the beginning will likely lessen avoidable, costly disputes down the line."

Meyer noted that, when you're drafting an operating agreement, the document needs to define the owners' roles, responsibilities and operating procedures. She recommended including terms relating to owner contributions; capital accounts; allocations of profits; losses and distributions; membership rights and voting with respect to matters affecting the company; management; disposition of ownership interest in the company in various instances; and other potential ownership-related disputes and circumstances. [4 Things No One Tells You About Business Partnerships]

If you've been in business for a while now and never considered an operating agreement, it's not too late to create a retroactive one. Think about how you've done business so far and decide what works and what may need to change moving forward, Meyer said. 

"Consider possible future scenarios, and determine how you would settle them in a reasonable manner if they occur," she said. "For example, will an exiting owner be able to sell their interest to a third party? How will you value that interest? What happens upon the death or permanent disability of an owner? It's also important to address terms related to finances, control and decision making."

No matter what stage your startup is in or whether you want to write an operating agreement, Meyer advised making a discussion about these types of ownership situations a top priority.

"People make assumptions that they're on the same page with their partner, and oftentimes, they're not," Meyer said. "It's crucial to determine the relationship between you and your partner early on and make it clear what you expect from each other. It also helps ensure you have the same vision and direction, which is important to establishing a successful, thriving business."

Nicole Fallon

Nicole Fallon received her Bachelor's degree in Media, Culture and Communication from New York University. She began freelancing for Business News Daily in 2010 and joined the team as a staff writer three years later. She currently serves as the assistant editor. Reach her by email, or follow her on Twitter.