If you’ve ever thought about starting a business with a partner or a small group, you might have heard about something called an “Operating Agreement.” It’s an important document that helps you run a Limited Liability Company — or LLC — smoothly and clearly.
An LLC is a popular business structure because it provides protection for its owners (called “members”) by separating personal assets from business liabilities. But what really keeps things organized is the Operating Agreement. This agreement is a written document that explains how the LLC will be managed, how decisions will be made, and what happens when things change.
Think of the Operating Agreement as the rulebook for your LLC. It clarifies everyone’s roles, responsibilities, and financial shares. Even if you’re the only owner, it’s a smart idea to have one because it keeps your business organized and protected.
One of the most important parts of an Operating Agreement is the buy-sell provisions. These are rules that explain what happens if a member wants to leave the business or can no longer participate. Life is unpredictable — people might die, get sick, get divorced, or face financial troubles. Buy-sell provisions help the business and its owners prepare for these situations to avoid confusion or conflict.
Here’s how buy-sell provisions help in common scenarios:
- Death: If a member passes away, the buy-sell provision can allow the remaining owners to buy the deceased member’s share. This helps keep the business running smoothly without outside parties (like heirs who might not want to be involved) suddenly owning part of the company.
- Disability: If a member becomes unable to work due to illness or injury, buy-sell terms can give the others the option to purchase that member’s interest. This keeps the business functioning without disruption.
- Divorce: When a member goes through a divorce, their ownership interest might be considered marital property. The buy-sell clause can protect the LLC by giving the company or other members the right to buy the share before it goes to an ex-spouse.
- Termination of Employment: If a member leaves the company (maybe quits or is fired), buy-sell provisions can specify how their ownership is handled. This avoids disagreements about whether the departing member can keep their share or must sell it.
- Bankruptcy: If a member files for bankruptcy, creditors might try to claim the member’s ownership in the LLC. Buy-sell provisions can restrict this by giving the LLC or other members the right to buy the interest before it passes to creditors.
- Criminal Conduct or licensure revocations: Certain business operations require the owners or operators to maintain specific licensures or a clean criminal history to function. If the owner operator is unable to participate in such functions due to a criminal conviction or a licensure revocation, the other members may need the right to remove the offending member in order to preserve the business.
- Improper transfer of the Membership Interest: Most members of a closely held business want to control the makeup of the ownership group. Buy-sell provisions can restrict this by giving the LLC or other members the right to buy the interest before it passes to
By planning ahead with buy-sell provisions, LLC members reduce the risk of unwanted owners, protect the company’s stability, and provide a clear way to handle changes. It’s like having an insurance plan for ownership interests.
Beyond buy-sell rules, some Operating Agreements include tag-along and drag-along rights. These terms might sound complicated, but they’re about fairness and control during the sale of ownership shares.
Tag-along rights protect minority owners. If a majority owner decides to sell their share to someone else, tag-along rights allow the minority owners to “tag along” and sell their shares on the same terms. This way, smaller owners don’t get stuck with new partners they didn’t choose.
Drag-along rights give majority owners the power to “drag along” minority owners in selling the entire company. If the majority decides to sell the whole business, drag-along rights force the minority to sell their shares too, usually under the same conditions. This makes selling the business easier by preventing minority owners from blocking the deal.
Both tag-along and drag-along rights help protect all members’ interests and keep sales fair and efficient. They ensure no owner gets left out or forced into something unfair when ownership changes hands.
Even though some states don’t require LLCs to have an Operating Agreement, it’s a smart and practical step for any business. The agreement helps avoid disputes, sets clear expectations, and plans for the unexpected. With well-crafted buy-sell provisions and tag-along/drag-along rights, your LLC is prepared for changes that could otherwise cause confusion or harm the business.
While it’s helpful to understand the basics of an Operating Agreement and its key provisions, it’s important to remember that every business is unique. Engaging a lawyer who specializes in business law can make a big difference. A lawyer will help draft an Operating Agreement tailored specifically to your LLC’s needs and goals, ensuring all important issues are covered. This includes careful attention to how the buy-sell provisions handle ownership changes, especially the method used to value a member’s share. Valuation is a critical factor — it determines the price paid when ownership interests are bought or sold, and having a clear, fair valuation process in your agreement can prevent disputes down the line. Working with a professional means you get peace of mind knowing your Operating Agreement protects both you and your business no matter what happens.
If you’re starting an LLC or already own one, consider creating or updating your Operating Agreement with these protections. It’s an important way to keep your business running smoothly, protect relationships, and safeguard your investment for the future.
