Anytime you have a destination to reach, it helps to have a roadmap of how to get there. As a professional services firm, your course is set by its shareholders, partners, or members, depending on its structure. So it’s vital for these individuals (we’ll refer to all groups as shareholders) to establish and agree on certain parameters in an operating agreement. Because these agreements are often not legally required, they are often overlooked or, even if drafted, sometimes ignored. But operating without one is like driving blind.
Unlike a contract dictating the terms of a one-time purchase or sale, your operating agreement addresses issues across the entire lifespan of your firm. Your operating agreement should be revised as industry standards, tax laws, your firm, and its shareholders evolve. It can help your professional services firm and its shareholders ensure equity, protect their investments, maintain competitiveness, plan for succession, and avoid unintended consequences.
An operating agreement helps you eliminate “what if’s.”
What if you wants to add shareholders down the road? What if a shareholder wants to leave, becomes incapacitated, or passes away unexpectedly? What if there is a consensus among other shareholders that a shareholder should be removed? What if some shareholders contribute cash or property to the firm, and others don’t?
An operating agreement helps you eliminate the what if’s by allowing you to plot out contractually:
- percentages of ownership;
- division of profit and loss;
- salary arrangements or guaranteed payments;
- division of duties;
- decision-making and voting rights among shareholders;
- how disputes are resolved;
- the length of the partnership; and
- how ownership equity will be handled after a shareholder exits the firm.
An operating agreement helps you maintain your competitiveness.
Your operating agreement can also provide your firm’s shareholders with a platform to lay out their agreed-upon payment models, lead generation methods, new client approval criteria, and other operational standards that help you grow your business.
To ensure the inclusion of new talent and fresh ideas, the agreement can include specifications for mandatory retirement, including whether a shareholder will continue employment after retirement and in what capacity. Your operating agreement should require all retirees to have a transition plan so that your firm retains the retiring shareholder’s clients, skills, and abilities.
The agreement should also outline the terms for payment of deferred compensation and other goodwill-based retirement benefits. Without an operating agreement, state law could require the firm to pay these benefits if the retired partner sues the firm, negating the firm’s ability to control the benefits. If your industry allows for it, you should also address non-compete or non-solicit agreements. For example, law firms are not permitted to include restrictive covenants.
An operating agreement can help your firm build a compensation plan that supports healthy recruiting & retention efforts. Compensation is a significant factor in attracting and retaining the right partners and can be based on agreed-upon amounts, percentages, performance, or the decisions of a compensation committee.
An operating agreement helps you plan for succession.
A buy/sell agreement is a critical component of an operating agreement. Suppose the founder or managing shareholder dies or becomes permanently disabled, and your firm doesn’t have an operating agreement in place. In this case, the state will automatically govern your firm’s future, regardless of your wishes or intent.
The buy/sell component is an essential part of the agreement because it provides a market for the shares in the event an owner dies or leaves the company. It establishes the price and terms for the market, so future transactions occur in an orderly and reasonable fashion. In addition, it specifies the financing available to acquire shares in the event an owner departs. Thus, buy/sell provisions maximize shareholder value and protect shareholders investments.
ARB’s Professional Services Firm Advisory Team provides tax, accounting, and advisory services to architecture firms, engineering firms, law firms, marketing agencies, and consulting firms so that they can shift the primary focus back to client service.
While attorneys are experts in drafting contracts, CPAs are experts in determining the tax implications of the decisions outlined in the agreement. I want to help you ensure your operating agreement is positioning your firm and its shareholders to meet their goals, now and in the future. If you’d like to discuss your strategy, contact me today.
by Jason LeBlanc, CPA
Jason LeBlanc joined ARB in 1997 and has been a principal for the firm since 2016. He is the Practice Leader for both ARB’s M&A Advisory Group and Nonprofit Advisory Services Group. Throughout his career in public accounting, Jason’s focus has been on M&A advisory services and providing accounting, compliance, and consulting services to clients in the professional services firms, nonprofit, and automotive sectors. He works extensively with organizations subject to Single Audit reporting requirements.