Why Every Business Needs a Custom Operating Agreement to Prevent Disaster (with Case Studies)
- Chris Johnsen
- Dec 29, 2025
- 5 min read
Through 15 years of experience as both an entrepreneur and business lawyer, our firm has witnessed the destructive power of inadequate governing documents, which often result in expensive legal battles that can destroy a business.
This article includes authentic governing document disaster examples to demonstrate why you should develop individual agreements that safeguard your assets and prevent legal problems.
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The Role of Governing Documents
A business operates through its governing documents, which function as its fundamental contracts. Limited liability companies (LLCs) operating in Texas need an operating agreement, which Texas calls a company agreement. Partnerships require partnership agreements, while corporations need shareholder agreements alongside buy-sell agreements and bylaws.
These legal documents serve more than ceremonial purposes; they establish owner rights and responsibilities, management structures, and decision-making protocols. They provide solutions for disagreements between owners, departures, or significant financial changes. Without a tailored agreement, a company is governed by state default laws which rarely match the specific wishes of the owners, leaving the business vulnerable to operational disputes.
Risks of Template and Default Statutory Rules
A business operating without customized governing documents must follow the standard default laws established by state statutes. These laws were created to handle basic relationships but fail to serve specific business needs or safeguard long-term interests.
Many business owners use online templates or AI-generated documents to save time and money. This shortcut typically results in future legal battles because general forms lack specific solutions for individual roles, contribution obligations, dispute resolution systems, and valuation procedures. Most owners fail to notice these shortcomings until a conflict has already developed, making oversight correction nearly impossible.
Case Studies: Governing Document Failures
Expulsion and Ownership Valuation Ambiguity
A trading company had an operating agreement stating members could be expelled for criminal conduct but failed to include provisions regarding ownership value assessment for those expelled. When a dispute arose, the business spent $60,000 on legal fees during a lengthy mediation because there was no agreed-upon method to value the departing member's ownership.
Minority Shareholder Vulnerability in High-Revenue Entities
A profitable interactive museum generated $10 million in annual revenue. Under its agreement, the majority owner retained complete authority over financial distributions. When the 15% minority owner was removed from their management position, they lost access to both decision-making and financial benefits. This demonstrates why protective measures, such as distribution guarantees or veto authority, are vital for minority owners.
Undefined Valuation Terms and Appraisal Conflict
A real estate agency had an operating agreement that used the term “fair value” for member removals but lacked a specific definition. It was unclear if this meant tangible assets only or included goodwill and future earnings. Two vastly different appraisals created confusion that nearly collapsed the transaction. The parties spent $10,000 on mediation just to interpret a single undefined term.
Absence of Finalized Agreements and Business Dissolution
A fire suppression company operating at $30 million annually failed to create a finalized operating agreement. When the partnership ended, one partner dismissed the other's spouse and blocked financial access. With no governing document, state law took over, leading to $30,000 in fees and the eventual destruction of a highly successful business due to unresolved personal conflicts.
Essential Clauses for Asset Protection
Expulsion and Termination Frameworks
The document must include specific provisions regarding member expulsion and termination that outline both removal criteria and the method for assessing departing interests.
Defined Valuation Methodologies
A valuation clause must state whether goodwill is included and define which metrics to use (such as EBITDA or book value) and whether an independent appraiser will be involved.
Financial Distribution and Tax Advances
Your agreement needs to establish the distribution method for profits and specify if tax advances will be given to members for their pass-through tax responsibilities.
Management Authority and Deadlock Resolution
Your agreement must specify who possesses authority, describing how decisions are made and providing a clear path forward when there is a deadlock.
Alternative Dispute Resolution and Restrictive Covenants
The dispute resolution section should provide for mediation or arbitration as substitutes for court battles. Additionally, non-compete and non-solicitation clauses safeguard the company by preventing departing members from taking company secrets or customer relationships.
Strategic Advantages of Custom Agreements
A properly crafted custom agreement functions as a protective shield, creating aligned expectations for dispute resolution. These agreements provide better protection than templates because they reflect the unique characteristics of your ownership structure, strategic goals, and industry standards. A well-designed agreement enables majority owners to lead effectively without exposing minority owners to financial harm.
Financial and Emotional Costs of Inadequate Planning
Many owners skip custom agreements to save money, yet disputes over unclear documents frequently exceed $10,000 in legal fees. Beyond the money, these ambiguities create emotional challenges that strain relationships between friends, spouses, and long-term colleagues. The initial expenditure on a solid agreement is both a mandatory legal requirement and a sound business strategy.
Implementation and Maintenance Strategies
Legal Counsel Engagement
Start by hiring a business lawyer who has experience in your industry sector. They will guide you through creating an agreement that accounts for essential operational scenarios.
Negotiation of Core Operational Terms
Business owners should negotiate essential terms into the agreement, including exit procedures, voting rules, and profit distribution systems, while the relationship is harmonious.
Periodic Reviews and Structural Updates
As your business grows, your agreement needs to adapt. Examine your governing documents regularly to ensure they reflect ownership shifts, revenue fluctuations, and strategic adjustments.
Summing It Up: Foundational Business Protection
A custom governing document is an essential requirement for any business. It provides protection from risk and establishes clear expectations that allow for operational stability. Creating a solid operating agreement is one of the most intelligent decisions you can make for your venture.
Take Action!
Contact Johnsen Law today to schedule a consultation about protecting your business through custom operating agreements. Our team stands ready to guide you through governing document prevention strategies to secure your company's future.
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