“The standard is the standard.”—Mike Tomlin, NFL Head Coach

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Welcome to Part 4 of our National Entrepreneurship Week Series. In our previous post, we discussed the importance of creating and executing an intellectual property protection strategy to protect your business. This post will focus on the standard agreements that small businesses and startups may need to get started. 

Understanding Standard vs. Standardized Agreements

It’s important to delineate between a “standard agreement” and a “standardized agreement.” A standardized agreement is one in which the counterparty has little or no ability to change. If you’re a widget maker and a major retail outlet wants to contract with you to sell your widgets in their stores, most of the agreement(s) you will sign with them will be standardized; meaning, you won’t be able to change it. In regard to a standard agreement—for the purposes of how we use that term—that is a type of agreement that forms the legal foundation for your company, such as an operating agreement, client agreement, or non-disclosure agreement. 

The Limitations of Legal Templates

A word about templates. The proliferation of digital legal services has led some to believe that, to start a business, all you need is a dollar, a dream, and a LegalZoom account. And that’s not how this works. To be fair, there are some use cases for companies offering digital legal services, which I won’t speak to here because they don’t pay me for advertising. That said, by and large, the best cases center around starting a company, not running a company. Once you’ve launched your organization, that job is done, and you generally won’t have to revisit any of that paperwork until it is time to open a bank account or file for renewal. The issue usually comes when your business, like many businesses, evolves. How you manage and operate it must then evolve. 

The Value of Custom Legal Agreements for Your Business

Very few attorneys have ever drafted a contract from scratch without copying from a starting point. It’s time-consuming for us and cost prohibitive for the client. Most seasoned attorneys have a bank of templates and models they borrow from to craft the complex documents produced for clients. Today, you may find sample agreements or contracts on the internet, which, in the right hands and written by authors well acquainted with the subject matter, may be useful time-saving tools. 

Your standard agreements should take into consideration the type of business and the state in which you operate. However, if you don’t understand the contract principles undergirding the template, there’s no way for you to understand just how useful it is to you and your specific needs. Additionally, certain states may require the use of specific language that could be missing from the template. Missing information has consequences. It can leave your business vulnerable to legal trouble and conflicts between LLC members. And that, my friends, is why you hire professionals. Thanks for coming to my TED Talk. 

Three Essential Agreements for Startups and Small Businesses

There are three types of agreements we generally recommend for any small business or startup, regardless of industry: (1) Operating Agreement; (2) Service Agreement; (3) Non-Disclosure Agreement. For more information on service agreements, we encourage you to read our post on spotting red flags in contracts. And the next post in this series is dedicated to non-disclosure agreements. For this post, we’ll focus on operating agreements.

‍What is an Operating Agreement?

An operating agreement is a key document used by limited liability companies (LLCs) that outlines the business’ financial and functional decisions, including rules, regulations, and provisions. The purpose of the document is to govern the internal operations of the business in a way that suits the specific needs of the business owners. Once the document is signed by the members of the LLC, it acts as an official contract binding them to its terms. As the operating agreement is an internal document, it is unlikely to go beyond the “walls” of the organization. 

‍Why Do You Need an Operating Agreement?‍

1. To protect the business’ limited liability status: Operating agreements give members protection from personal liability to the LLC. Without this specific formality, your LLC can closely resemble a sole proprietorship or partnership, jeopardizing your personal liability.
2. To clarify verbal agreements: Even if members have orally agreed to certain terms, misunderstanding or miscommunication can take place. It is always best to have the operational conditions and other business arrangements handled in writing so they can be referred to in the event of any conflict.
3. To protect your agreement in the eyes of your state: State default rules govern LLCs without an official operating agreement. This means that each state outlines default rules that apply to businesses that do not sign operating agreements. Because the state default rules are so general, it is not advisable to rely on a governing body state to manage your agreement.
4. To provide for conflict resolution: Conflict is inevitable, but it does not need to be fatal to the business. If there are carefully prescribed and mutually agreed upon rules to settle disputes of management, finances, and intakes of new members, then it is less likely to result in a dissolution. Plus, in the event a dissolution is ultimately deemed the best course of action, a well-formed operating agreement can save you from engaging in costly litigation.

‍What Is Included in an Operating Agreement?

The functionality of internal affairs is outlined in the operating agreement, including but not limited to the following:

• Percentage of members’ ownership
• Voting rights and responsibilities
• How the LLC will be managed by its members or manager
• How the management team will be selected
• How key business decisions will be made
• How profits, losses, and tax items will be allocated among the members
• What actions require a vote by the members (and what percentage is required for approval)
• Duties and responsibilities of the members
• Procedure for transferring ownership interests or bringing in additional members
• Events that could trigger the dissolution of the LLC
• Succession plans (by reason of death or incapacitation of one of the members)
• When and how the LLC will be dissolved

Once your agreement is signed, keep copies along with your other confidential business records. The LLC operating agreement should be reviewed annually to ensure it still reflects the wishes of members and addresses operational issues that override the default provisions of state law. 

Diplomatic Enterprises specializes in collaborating with athletes, brands, and creatives to launch and grow their small businesses. Whether you find yourself at the beginning of your entrepreneurial journey or somewhere between start and finish, call or email us for a free consultation. Come back tomorrow for the fifth and final part of our National Entrepreneurship Week Series: How NDAs Really Work. 

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