When friends, family members or business partners join forces to launch a company – whether to start a new venture, invest in real estate or pursue another opportunity – excitement usually runs high. What’s often overlooked, however, is the importance of putting clear legally binding agreements in writing.

A well-crafted operating agreement is essential when forming a limited liability company. It establishes how the company will be owned, managed and operated, and it can prevent conflicts that might otherwise jeopardize the business later.

Here are seven critical issues every LLC operating agreement should address.

1. Capital contributions, ownership interests & control

Your operating agreement should clearly spell out:

• Each owner’s initial capital contribution.
• Their percentage of ownership and share of profits and losses.
• The priority or order of distributions.
• Whether owners will be required to make additional capital contributions if the company needs more funding.

It should also define who will manage the business – either designated managers or the managing members – and how major decisions will be made. For example, big moves like acquiring another business, selling key assets or entering into major loans may require approval by a majority or supermajority of owners rather than just a simple 51% vote.

2. Restrictions on ownership transfers

Without clear rules, one owner could sell their interest to an outsider who doesn’t have the right experience or who simply isn’t a good fit.

A strong operating agreement includes transfer restrictions, such as:

• Requiring approval from all other owners before a new owner can join.
• Granting the company or other owners a right of first refusal, allowing them to purchase the individual’s interest at the same price and on the same terms and conditions as those offered to the outside party.

These protections help maintain stability, ensure that ownership remains among trusted parties and give existing owners the opportunity to increase their shares.

3. Protecting confidential information and trade secrets

Restrictive covenants are another key component. The agreement should:

• Require owners (and employees or contractors) to protect confidential information and trade secrets.
• Prohibit owners from using company information for personal gain.
• Include non-compete provisions that prevent departing owners from immediately competing with the business.

Ohio law generally upholds reasonable restrictive covenants, so addressing these issues early – before anyone leaves – is far easier than trying to fix them during a dispute.

4. Buyout provisions for a deceased owner

The death of an owner can create complex legal and financial challenges. A buyout provision helps prevent disputes by:

• Requiring the company or remaining owners to purchase the deceased owner’s interest at a predetermined fair price.
• Specifying how the buyout will be funded, such as through life insurance policies.

Without such a provision, ownership may pass to heirs who aren’t interested or qualified to participate in the business, leading to unwanted complications or outside ownership.

Also, as a result, the remaining owners may not want to be co-owners with the spouse or child of a deceased owner since he or she may not have the financial wherewithal or skills, knowledge or desire necessary to become actively involved in the business, or may lack the necessary personal compatibility. 

Additionally, since closely held Companies generally do not pay dividends, an individual holding onto the deceased owner’s interest will not usually receive any regular income stream from the investment. 

5. Buyout rights in cases of retirement, disability, divorce, bankruptcy or poor performance

The agreement should also allow for a buyout if an owner:

• Retires, becomes disabled or faces personal financial issues such as bankruptcy or divorce.
• Competes directly with the company.
• Fails to perform at an acceptable level.

Clearly outlining triggering events and buyout procedures upfront avoids confusion and helps protect the company’s long-term stability.

6. Clear buyout method & pricing formula

Specifying how a buyout will be calculated and executed is just as important as deciding when it happens. The agreement should cover:

• Notice and timing requirements.
• Right-of-first-refusal procedures.
• How the purchase price will be determined.

Depending on the type of business, there are many ways to determine the price of an owner’s interest, including:

• Appraisal from an outside source at the time of the buyout.
• Periodic valuation of the interest, set by the owners of the company on an annual basis.
• Percentage of gross income.
• Book value, determined by deducting the company’s liabilities from assets and dividing the figure by the number of outstanding owner’s Interests.
• A formula based on a multiple of earnings, which multiplies the company’s last year of earnings by a fixed number, and divides the figure by the number of outstanding owner’s interests. 
• Average of earnings over a three- to five-year period. 

A fair and well-defined pricing mechanism reduces disputes and ensures smoother ownership transitions.

7. Mandatory buy/sell (deadlock) provisions

When two or more owners each hold 50% of the company, deadlocks can occur. A mandatory buy/sell clause – sometimes called a “put and call” provision – offers a clean solution.

In this scenario, one owner can make a buyout offer to the other at any point in time. The recipient must either accept the offer and sell or purchase the first owner’s interest on the same terms. This structure encourages fair pricing and gives both parties a clear path out of an unworkable situation.

Final thoughts

It’s easy to assume that close friends or relatives don’t need formal agreements. In reality, uncertainty and conflict often arise when an owner wants to sell, retires, becomes disabled, divorces or passes away.

A well-drafted operating agreement is the single best way to protect everyone’s interests and keep your business running smoothly. Addressing these issues early isn’t just smart legal planning – it’s a crucial step toward long-term success.

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Shawna L. L’Italien, a business lawyer in the Salem office of Harrington, Hoppe & Mitchell, focuses her practice on business financing and organization, employment law, succession planning and mergers and acquisitions. She can be reached at (330) 337-6586 or at slitalien@hhmlaw.com.