As a co-founder, there are numerous responsibilities that fall on your plate. One of the most essential is working through various questions before writing an operating agreement. An operating agreement is a legal document that outlines the rights and responsibilities of each co-founder and the business itself. It is a critical document that helps establish the company’s foundation and ensures that all co-founders are on the same page.
Before beginning to draft an operating agreement, co-founders should consider the following questions:
- What is the structure of the company?
- Will the company be a partnership, corporation, or limited liability company (LLC)?
- Who will be the owners (also known as members or shareholders) of the company?
- What percentage of ownership does each co-founder have?
It is important to clearly define the structure of the company in the operating agreement. The choice of business structure will have significant legal and tax implications, so it is essential to choose the right one for your company. A partnership is a business owned by two or more individuals who share profits and losses. A corporation is a separate legal entity that is owned by shareholders and managed by a board of directors. An LLC is a hybrid structure that combines the liability protection of a corporation with the tax benefits of a partnership.
The operating agreement should also clearly define the company’s ownership structure. This includes the percentage of ownership held by each co-founder and any additional owners or investors. Determining the ownership percentages at the outset of the company is essential, as it will impact how profits and losses are shared and how decisions are made within the company.
- How will decisions be made within the company?
- Will decisions be made by a majority vote or by consensus?
- Who will have the final say in the event of a disagreement?
- How will new members or investors be brought on board?
The operating agreement should outline the process for making decisions within the company. This can include a majority vote system, where decisions are made based on the majority of votes, or a consensus-based system, where all co-founders must agree on a decision before it can be implemented. It is essential to determine the decision-making process upfront to avoid disputes down the line.
In the event of a disagreement, it is also important to have a clear process for resolving disputes. This can include mediation or arbitration, where a neutral third party helps to facilitate a resolution. It is also important to consider who will have the final say in the event of a deadlock.
The operating agreement should also outline the process for bringing new members or investors on board. This can include the requirements for becoming a member or investor, as well as the process for issuing new shares or membership units.
- How will profits and losses be shared?
- Will profits and losses be shared equally among co-founders, or will they be based on each co-founder’s ownership percentage?
- How will profits be reinvested in the company?
The operating agreement should specify how profits and losses will be shared among co-founders. This can be based on each co-founder’s percentage of ownership or on a predetermined formula. It is essential to clearly define the profit and loss sharing structure to avoid disputes and ensure that all co-founders are treated fairly.
The operating agreement should also outline how profits will be reinvested in the company. This can include using profits to fund new initiatives, pay off debt, or distribute dividends to shareholders.
- How will the company be managed?
- Who will be responsible for managing the day-to-day operations of the company?
- How will major business decisions be made?
- Will there be a board of directors or a management team?
The operating agreement should outline the management structure of the company and specify who will be responsible for managing the day-to-day operations. This can include assigning specific tasks and responsibilities to each co-founder or hiring a management team.
The operating agreement should also outline the process for making major business decisions. This can include a majority vote system, where decisions are made based on the majority of votes, or a consensus-based system, where all co-founders must agree on a decision before it can be implemented.
Depending on the company’s size and complexity, a board of directors or a management team may be necessary to assist with decision-making and management. The operating agreement should outline the responsibilities and composition of these groups.
- How will disputes be resolved?
- What process will be followed in the event of a dispute between co-founders?
- Will disputes be resolved through mediation or arbitration?
Disputes are an unfortunate but common occurrence in business, and it is essential to have a clear process for resolving them. The operating agreement should outline the steps to be taken in the event of a dispute between co-founders. This can include mediation or arbitration, where a neutral third party helps to facilitate a resolution.
Mediation involves bringing in a mediator to help facilitate a resolution between the parties involved in the dispute. The mediator is a neutral party who helps to facilitate communication and negotiation between the parties but does not have the authority to make a decision.
Arbitration is a more formal process in which an arbitrator hears both sides of the dispute and makes a binding decision. The decision of the arbitrator is final and cannot be appealed.
- How will the company be dissolved?
- Under what circumstances can the company be dissolved?
- How will the assets of the company be distributed in the event of dissolution?
It is important to consider the possibility of dissolution and outline the process in the operating agreement. The operating agreement should specify the circumstances under which the company can be dissolved and outline the process for doing so.
The operating agreement should also outline how the assets of the company will be distributed in the event of dissolution. This can include distributing assets to the co-founders or shareholders based on their percentage of ownership or following a predetermined formula.
- How will intellectual property be handled?
- Who will own the intellectual property created within the company?
- How will intellectual property be used and licensed?
- Intellectual property refers to the creations of the mind, such as inventions, literary and artistic works, and symbols, names, and images used in commerce. It is essential to clearly define in the operating agreement who will own the intellectual property created within the company and how it will be used and licensed.
- In some cases, co-founders may want to retain ownership of their individual intellectual property, while in other cases, they may want to assign ownership to the company. It is essential to determine this upfront to avoid disputes down the line. The operating agreement should also outline how the company’s intellectual property will be used and licensed. This can include granting licenses to third parties to use the intellectual property or restricting its use within the company.
- What are the roles and responsibilities of each co-founder?
- What specific tasks will each co-founder be responsible for within the company?
- Will co-founders have defined job titles, or will they perform various tasks?
- It is essential to clearly define each co-founder’s roles and responsibilities in the operating agreement. This can include assigning specific tasks and responsibilities to each co-founder or giving them broad responsibility for certain areas of the business. Co-founders may also have defined job titles, such as CEO or CFO, or they may perform various tasks as needed. The operating agreement should outline the job titles and responsibilities of each co-founder to ensure a clear understanding of who is responsible for what within the company.
- How will compensation be determined?
- Will co-founders receive a salary or be compensated through the distribution of profits?
- How will the amount of compensation be determined?
The operating agreement should outline how co-founders will be compensated for their work. This can include a salary, a percentage of the company’s profits, or a combination of both.
If co-founders will be paid a salary, the operating agreement should specify the amount and frequency of the salary payments. If co-founders will be compensated through the distribution of profits, the operating agreement should outline the formula for determining the amount of the distribution.
By answering these questions, co-founders can gain a clear understanding of how the company will be structured and operated. This will help to ensure that the operating agreement accurately reflects the needs and goals of the company and its co-founders.
It is important to note that an operating agreement is a legally binding document that should be carefully drafted with the assistance of an attorney. It should also be reviewed and updated periodically to ensure that it accurately reflects the company’s current state.
By considering these issues, co-founders can create a strong foundation for their company and ensure that all co-founders are on the same page. Forte has helped guide many small business owners as they navigate executive roles. Our Executive Coaching services can help founders with co-founder agreements and all of the various responsibilities executives face.
