Businesses with multiple owners should have an operating agreement and valuation tactic
Problems arise when times are tough.
Business ownership types that are not single member LLC’s or sole proprietorships should have an operating agreement. Partnerships should have a partnership agreement. When times get tough, you will want to refer to a written plan to resolve issues.
An operating agreement for LLC’s and S-Corps, and partnership agreements for partnerships are good documents to have. Most businesses are cyclical or seasonal. Therefore, you may experience a rough patch, a time when you need to make critical decisions without undue emotional influence. A prewritten agreement is a tool to help guide you through tough decision making.
In its most simple form, an agreement spells out the duties for each member, partner or shareholder. The duties can be divided, shared or hired out, but each person is assigned an area of responsibility in the business functions. Also, agreements will spell out how decisions will be made in cases where unresolved conflict arises. Written agreements explain the pay structure for each equity holder, how equity is vested and its schedule, forfeiture provisions, and most importantly, how the business is valued.
When an equity holder wants to exit the business, a provision written into the agreement will spell out how the person will be compensated for their equity stake. This can be written with the assistance of a competent attorney, together with the advice of your CPA because of tax issues. One big hurdle will be how to value the business.
Your agreement should spell out the valuation method used to calculate the value of the business. You can find many ways to value a business with the assistance of a competence attorney together with a CPA. When I consult with a business on this matter, I recommend that the business is valued each first of January (or March, or June). As long as it is done annually, you can value the business for the upcoming year, and if an equity holder wants out of the business, the value of the business is previously established, and there will be no conflict over the buy-out price.
Many other stipulations go into an operating or partnership agreement. You may need a competent attorney together with a CPA to have all stipulations written into your agreement.
Paul J. Werner is an Michigan State University Extension educator from L’Anse, Michigan. You can obtain free business counseling by registering with the MSU Product Center. Werner has many years experience in small business ownership and entrepreneurship. He and his wife currently own two small businesses in the Upper Peninsula of Michigan.