What Is an Operating Agreement
An operating agreement is the internal governance document for your franchise business if you structure it as an LLC. It defines how your company operates internally, including member roles, profit distribution, decision-making authority, and what happens if a member leaves or dies. This is separate from your franchise agreement, which governs your relationship with the franchisor.
Operating Agreement in Franchise Context
Most franchise agreements require you to operate through a legal entity (usually an LLC or corporation) rather than as a sole proprietor. Your operating agreement is where you establish the rules for that entity. If you have co-investors or family members involved, the operating agreement spells out voting rights, capital contribution requirements, and how profits split.
Many franchisors ask to review your operating agreement before approving you as a franchisee. They want to verify that decision-making authority clearly rests with you, not with passive investors who might dispute operational decisions. Some franchise disclosure documents (FDDs) reference operating agreement requirements in Item 19, which covers franchisor-provided assistance and services.
Key Considerations for Franchise Buyers
- Transfer and Renewal: Your operating agreement should address what happens if you want to transfer the franchise to another member or sell the business. Franchise agreements typically require franchisor approval for transfers, so your operating agreement can't override that, but it sets internal rules about how members decide to pursue a sale.
- Capital Requirements: Document the initial capital contribution from each member. If the franchisor requires you to maintain a minimum cash reserve (common in food service franchises), your operating agreement can enforce that requirement internally.
- Dissolution Clause: Specify what happens if the franchise agreement terminates or is not renewed. Many franchise agreements impose a 6 to 12-month wind-down period after the term ends. Your operating agreement should clarify member obligations during that period.
- Dispute Resolution: Consider including an arbitration clause for internal disputes between members, separate from franchise agreement dispute resolution procedures.
- Manager vs. Member-Managed: Decide whether one member manages the LLC or all members participate in decisions. This affects daily operational speed and liability concerns.
Common Questions
- Do I need a lawyer to draft my operating agreement? Yes, especially if you have multiple members or significant capital at stake. A franchise-experienced attorney costs $1,500 to $3,500 for a custom operating agreement but protects you from costly disputes later. Using a template from online services increases the risk of conflicts with your franchisor's requirements.
- Can my franchisor dictate my operating agreement terms? The franchisor cannot dictate your entire operating agreement, but they can require that it gives you operational control and doesn't create competing obligations. Review Item 19 of the FDD to see if the franchisor lists any specific requirements for entity structure.
- What happens if I don't have an operating agreement? Many states default to statutory LLC rules if you operate without one. These default rules may not protect your personal assets as effectively or may give all members equal control regardless of capital invested. You also won't have clear procedures for adding or removing members.