Business Management

Think Your Business Plan is Flawless? Don’t Forget This Key Element!

Expertise: Real Estate Investing Basics, Real Estate Deal Analysis & Advice, Mortgages & Creative Financing, Landlording & Rental Properties, Business Management, Personal Development, Flipping Houses, Commercial Real Estate
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About a month ago my husband Matt and I were sitting in a real estate closing. We were doing the typical "closing" activities. We were busy signing paperwork and keeping an eye on our 10 month old. (Yes, our little guy has already been to two real estate closings!)

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We had one of our three real estate attorneys with us during the closing.

SIDE NOTE: Yes, we actually work with three real estate attorneys. Some might think we are crazy, but each attorney has a different expertise that we utilize in our business. One has a specialty in evictions. One has a specialty in buying large apartment buildings. The other one is terrific at the day-to-day real estate issues that arise. We have found having a team of experts around us very beneficial as we have grown.

Okay, now back to the real estate closing….

How I Learned the Importance of an Operating Agreement

Somehow, we got on the topic of LLC's, annual meetings and operating agreements. For most real estate investors, this is not the most exciting topic. However, our attorney and I got into a discussion that led me down an interesting path.

Annual meetings had come up in our discussion.

Related: The Anatomy of a Real Estate Contract

So I asked our attorney, “How do you know if it is necessary to even have annual meetings?”

Then my attorney turned to me and said something that stuck with me, “It actually depends on what exactly is spelled out in your operating agreement about meetings. Your operating agreement dictates what you should and should not be doing in the company. You don’t want to be ignoring any of the governing rules in your operating agreement. Remember, the operating agreement protects your limited liability status.” In short, this meant that to keep the liability protection of the company, we had to actually do what it says in our operating agreement.

As I drove home from the closing, I kept thinking about our attorney’s comments. He really made me stop and think about how confident I am about our current agreements.

I spoke to Matt and asked him if he was clear on the “governing rules” of all of our operating agreements. Since I did not get a straight answer, I decided to embark on the fairly detailed, but important project of reviewing each and every one of our operating agreements.

The reason I wanted to review all our operating agreements is not because I am an attorney, am bored with nothing to do or even because I like doing a lot of detail work (because I really don’t!). However, we have been growing quickly in the last few years and subsequently continue to purchase more and more properties with various partners. To date, we have over a dozen Operating Agreements. So as I embarked on this project and am still working on it today, I wanted to share some learnings that might help you in your real estate business…

5 Factors You Need to Consider About Business Operating Agreements

1. Actually Have an Operating Agreement

I have come to understand that operating agreements are not required in all states.

Actually, in the state of NJ, where we do most of our real estate investing, it is not required that we have an Operating Agreement. However, I am so glad that we began utilizing Operating Agreements in 2004.

Operating Agreements have so many benefits that include clarifying the structure of your company, protecting your limited liability status and governing the actual rules of your company. It is imperative to have this type of clarity when you have anyone else involved in the business — spouses, partners, etc.

No one wants to think about, “What happens if this partnership does not work out?” and would rather simply have a “handshake agreement.” However, this shortcut is a mistake.

Having an Operating Agreement in place (not just a handshake) will help ensure everyone is on the same page while the business is active, as well as if the business has to be dissolved for some reason. Many of our operating agreements even include a death clause in case one of the partners passes away. Again, this is something you don’t want to think about or consider, but life, as we all know, keeps moving, and you want to protect yourself and everyone involved in your company from the BEGINNING!

2. Create a Practice to Review Your Operating Agreements Once a Year

As I reviewed the first few LLC Operating Agreements we created, I soon found out that we mistakenly never updated our registered office in one of our first LLC’s that was formed in Pennsylvania.

Related: Contract Law 101: When is a Deal actually an Enforceable Deal?

We originally began investing in PA, so it made sense at the time that we used our PA address as the registered office. However, we thought we updated this, and it turned out that we had not.

Although this was a simple oversight, this could have been avoided if we had a practice in place to review operating agreements once a year. You better believe we will begin instituting this practice moving forward.

3. Be Wary of Online Templates

As I reviewed our 10-plus agreements, I realized very quickly that every time my husband formed a new operating agreement with a NEW partner, he also created a NEW operating agreement each and every time!

As I was reviewing all the different operating agreements, I realized we had so many different “templates.” Real estate investors need to be careful and cautious when utilizing “online templates.”

Listen, I know that it is sometimes cheaper to simply pull something off the internet and call it “good.” However, I would not make that mistake when creating an operating agreement. I would be very careful that the online template complies with your state and local laws.

Moving forward, we now have one template for LLC operating agreements formed with strategic partners and one template we use only for LLP operating agreements with equity investors.

4. Make Sure to Actually Do Everything in Your Operating Agreement

Okay, this one might seem obvious.

However, through the years I have experienced a lot of real estate investors simply using “online templates,” which they have never fully reviewed. During my review of our operating agreements, I found that some of our operating agreements did not even mention annual meetings. Some of the earlier operating agreements did mention annual meetings. One actually called for an annual meeting on a specific day every year!

Again, we can’t be all over the place with annual meetings or anything in our agreements. We need to be consistent.

Most of these operating agreements discuss capital contributions, financial distributions and record keeping of financials. The specifics of these topics will change from agreement to agreement. However, there are sections of the agreement that should remain consistent that way you can ensure everything in that agreement is being executed.

The quickest way to open yourself up to liability is to act as if the operating agreement is just a formality and that it is not being used to run the business.

5. Consider Having an Attorney Help

We now use a very knowledgeable attorney who helped us create the in-house “templates” I was discussing earlier in the blog post. He has been very helpful to include sections of the operating agreement that will protect us and all of our partners.

We first brought him in to help us create the LLP (limited liability partnership) operating agreement. This is the type of entity we use with our equity partners. All of these equity partners have put in a financial contribution, and the operating agreement spells out from A-Z how their financial contributions will be handled, the general structure of the company and percentage of ownership.

This is an important one. It is important and quite honestly imperative to have in writing what percentage of ownership each partner will have in the company.

Our attorney included parts of the LLP operating agreement that we would never have thought of ourselves or even find in some online template we purchased for $50. Of course, engaging an attorney is perceived to be more expensive. But I would argue it is more expensive not to include an attorney.

I heard a wonderful real estate teacher once say, “Pay for good advice. You either pay now or pay later. I would rather pay now!”  There is a lot of truth in that statement.

Conclusion

Bottom line – I would caution you to take your business operating agreements seriously. Don’t just use something that you did not review closely to go through the motions.

This operating agreement can help you if you let it do so!

Happy investing,

Liz

Do you currently have a business operating agreement? Did you draw it up yourself or use an attorney? Would you add anything to my list?

I’d love to hear from you in the comments section below!

Matt Faircloth, co-founder and president of the DeRosa Group, is a seasoned real estate investor. The DeRosa Group, based in historic Trenton, New Jersey, i...
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    Jamie
    Replied about 6 years ago
    Thank you for this post, Liz! This is the stuff no one wants to think about, but it is so important. How did you find your Real Estate Attorneys? I am about to start looking for some in my area. Do you have any advise on how to begin this search?
    Liz Faircloth
    Replied about 6 years ago
    Hi Jamie, Thanks so much for your comment! I agree – not always the most exciting topic, but certainly important! Great question. Are you a member of any business networking groups? Some of the groups I am thinking…Chamber of Commerce, Referral type networking (BNI type of group), or even local REIA groups? These might be great places to get recommendations for your area specifically. Also, do you know any successful real estate investors in your area? These are also great resources for contacts, etc. Have you began working with any of the following….an accountant, title agent, insurance agent, or even real estate agent? These are folks who are great sources to meet other important people you will need on your team. Last thought – you could always join local groups on facebook and/or linkedin and this might be another way to get some recommendations. I hope this helps!! Good luck!! Liz
    flats in jaipur
    Replied about 6 years ago
    This is exactly how I do business.
    Liz Faircloth
    Replied about 6 years ago
    Great to hear, Flats! Thanks too for reading and commenting on the blog post! Let me know if I forgot anything! Thanks.
    JerryW.
    Replied about 6 years ago
    Liz, excellent article. Anyone who decides to form a corporation of any kind to limit his liability needs to truly understand it and how it works or they may have just wasted the money they spent on forming the company.
    Elizabeth Faircloth
    Replied about 6 years ago
    Thanks Jerry for reading my blog post! And I can’t agree more with your comment!! Happy investing!!
    Frankie Woods
    Replied about 6 years ago
    Awesome article! I just found out about Operating Agreements last week, so this article really struck a cord! And I agree with all of your points! This is such an important aspect of running a business “the right way”.
    Liz Faircloth
    Replied about 6 years ago
    Thanks Frankie for the comment! Glad this blog post was helpful to you. Good luck to you as you put these operating agreements together. Not the most exciting real estate task, but an important one!!
    Sharon Tzib
    Replied about 6 years ago
    And remember – those annual meetings are 100% tax deductible. I’ve held annual meetings in some pretty great locations in the past.
    Aaron Tjomsland from Swarthmore, Pennsylvania
    Replied about 3 years ago
    time for me to put together an operating agreement…. awesome. thanks,
    Dave Ripka from philadelphia, pa
    Replied about 2 years ago
    SOO0000oooo glad I join up with you all Good luck
    Maria P Soriente
    Replied about 1 year ago
    I am all new to this so thank you, Liz, for sharing. I am learning as I go along and try to build my real estate business learning from you all. I'll make sure that I don't skip on "paying for the right advice." Much appreciated!
    Timur Absalikov New to Real Estate from New York
    Replied 28 days ago
    The article has a good points, this year has modificated business a bit
    Sherri R Feest
    Replied 22 days ago
    Thanks for this blog, Liz. I am just getting started and this is one of my biggest stumbling blocks. In fact, it has completely stopped me in my tracks. There are some big, nationwide companies that specialize in this stuff and my fear is using anyone BUT one of these big companies. However, even the big companies seem to disagree on issues around the best way to set up your business (this comment is not so much Operating Agreement related, but a real estate attorney is still one of the first people you need to decide on to work with in order to get started).