Restaurant and bar owners typically devote much of their time and effort toward planning the more tangible aspects of running a restaurant, like finding the perfect space or designing a cost-effective menu.
Sadly, they often overlook one very critical aspect of running a business: Establishing their company’s legal structure.Many restaurant owners choose to organize their business as a limited liability company (LLC) due to the flexible structure and tax advantages that LLCs offer. LLCs are flexible because they are governed by a unique, tailor-made contract created by the restaurant's stakeholders called an LLC Operating Agreement.
If your are a member of an LLC, creating an Operating Agreement for your restaurant is crucial to ensuring both the long-term health and success of your venture and to keeping you and your partners out of potential litigation later on down the road.
What Is An Operating Agreement?
An Operating Agreement is a legal agreement between owners — called members — of an LLC that outlines how the company will conduct its business.
An LLC, or “limited liability company,” is a type of private company. It is run by members, which in other business structures might be referred to as owners or partners. The structure of an LLC gives certain tax benefits and protects the members from being held personally liable for the company’s debts, other operational costs, or shortcomings.
The restaurant industry is a fast-paced world where things are constantly changing and shifting. This is why restaurant owners often choose to structure their business as an LLC because of the flexibility it allows with regard to determining the roles, responsibilities, and rights of members.
Ideally, an LLC Operating Agreement will anticipate future problems and offer pre-determined solutions. Operating agreements dictate the economic and managerial rights and responsibilities of members – issues which, without such an agreement, are often hotly contested later in a company’s lifespan.
Each state has its own rules regarding Operating Agreements; In New York, for example, the law requires that any company organized as an LLC draft and maintain a written Operating Agreement. Regardless of its legal necessity, Operating Agreements are invaluable from a practical standpoint.
The Benefits of a Restaurant LLC Operating Agreement
A well-written Operating Agreement will help answer questions about:
Every restaurant or bar will have its own unique ownership structure; ownership and profit interests should be clearly defined in an Operating Agreement.
Typically, members of an LLC will own a different percentage of the business, which may or may not correlate with that member’s interest in company profits. Additionally, members may play unique roles in the company, which may entitle them to additional compensation or equity.
For example, one owner may be responsible for the day-to-day management of the restaurant while another may simply be a passive investor. Operating Agreements spell out these responsibilities and can also dictate how members may be removed from the LLC if relationships turn sour.
2) Intellectual Property
In addition to the ownership structure, the Operating Agreement should also discuss the ownership of the company’s intellectual property (IP).
A company’s IP is an abstract concept that will differ from company to company, but it typically refers to things like the company’s name, logo, and ideas (e.g. trademarks, copyrights, recipes, operation manuals, patents, etc.). As a restaurant builds its reputation and gains name recognition, IP can become a valuable asset of the company. In some cases, the IP of an organization could be more valuable than its physical assets.
3) Voting Rights
When it comes to voting on major decisions or business actions, LLC Operating Agreements typically outline the rights each member has, usually correlating with their role in the business.
For example, a passive investor may not be entitled to choose which vendors the company hires, but may be empowered to veto a company sale.
Larger LLCs typically give day-to-day control of the company to one member or a few select members, while smaller LLCs may be run by all of its members.
There is no “right answer” in determining how your business’s decisions are to be made. The key is making it clear in your Operating Agreement who can make decisions and when.
4) Distributions and Management Fees For Members
In an LLC, members are entitled to a certain fixed percentage of company profits, also known as a distribution.
It is a common misconception that a member’s percentage ownership must directly correspond to a member’s interest in company profits. For example, an Operating Agreement can dictate that a member who owns 95% of a LLC may only be entitled to 5% of the LLC’s profits.
This flexibility also allows LLCs to “reward” investors by giving investors priority over other members, with respect to profit distributions. A restaurant is a generally seen as a risky investment, so offering investors priority in profit distributions may help to attract them to the project.
Because equity ownership does not necessarily relate to profit interest, it is crucial that investors and entrepreneurs alike carefully review the “distributions” section of the restaurant’s Operating Agreement.
If you are a member of your business’s LLC and you also manage the day-to-day operations of your bar or restaurant, it is recommended that you take a management fee in addition to your distributions. Distributions are contingent on specific business results outlined in your Operating Agreement, while management fees are based on the responsibilities of a member’s role.
Restaurants may not be profitable for a substantial period of time and you should be rewarded for your hard work. Operating a restaurant is stressful enough—you don’t need the additional turmoil of living without a steady income.
Pro Tip: Members’ salary information can be included in your LLC’s Operating Agreement.
5) Sale of Interests
One of the most important functions of an LCC Operating Agreement is outlining how equity may be sold to and from members.
Generally, your restaurant’s Operating Agreement should anticipate worst-case scenarios, like the death or incapacitation of a member. By planning ahead, members can easily accommodate and facilitate unplanned changes of ownership.
Oftentimes, small or family-owned businesses find themselves in a court battle between current stakeholders after the death of the original owner. A well-written Operating Agreement helps restaurants avoid these scenarios and allows for a smooth transition of ownership in these cases.
Operating Agreements can also address deliberate sales of equity. It is common for members of a LLC to want to sell part or all of their interest at some point in time, based on the lifecycle or health of the company. Your restaurant’s Operating Agreement will determine whether members are allowed to freely sell or transfer their equity, or whether they must obtain consent from other members in order to do so.
An Operating Agreement Is Your Restaurant's Best Friend
LLCs are known for their flexibility and allow their members to dictate nearly every aspect of their management and operations through written Operating Agreements.
Having a carefully drafted Operating Agreement allows LLC owners to cruise forward with confidence, knowing that future problems and questions already have clearly defined answers.