Business Advisory Services
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Posted Thursday, April 30, 2026
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An operating agreement is one of the most important documents your business will ever have, and also one of the most overlooked.
It is the rulebook for how your LLC operates. It defines ownership, control, distributions, decision-making, and what happens when things go wrong. Most people treat it like a formality. Download a template, let an attorney draft something standard, sign it, and move on.
That works until it doesn’t.
At WCG, we do not draft operating agreements from scratch as attorneys do. Instead, we review, stress-test, and refine them. Because in our experience, even well-drafted agreements often miss the practical, financial, and tax-driven nuances that matter most once the business is up and running.
Distributions, Taxes, and Cash Flow
This is where we see some of the biggest disconnects.
In pass-through entities like LLCs and S corporations, owners are taxed on profits whether or not those profits are distributed. That creates a real issue. You could have taxable income allocated to you and owe a tax bill even if the business keeps all the cash.
Here is a simple example. The business has $100,000 in net income and everyone agrees to reinvest it into inventory. Fine. But all the owners still have a tax obligation based on that $100,000. If you are a 25% owner at a 22% marginal tax rate, you are looking at a $5,500 tax bill out of your own pocket with nothing distributed to cover it.
A well-structured operating agreement should address how working capital is defined, how much cash must remain in the business, how distributions are calculated, and whether there are minimum distribution requirements.
For example, you might define working capital as six months of operating expenses plus upcoming capital expenditures plus a buffer. Anything above that becomes available for distribution. The agreement might then require a minimum 40% distribution unless all owners agree otherwise, which helps offset the tax sting of allocated income.
One sidebar worth knowing. Growing working capital itself has a tax consequence. If you increase working capital from $100,000 to $200,000 next year, you will pay tax on that $100,000 of retained earnings. At a 22% marginal rate, that is $22,000. The good news is that reducing working capital later produces tax-free distributable cash.
Without this kind of framework, distribution decisions become emotional or political instead of objective. And minority owners tend to get squeezed the hardest.
Dispute Resolution and Valuation
Templated operating agreements usually include language about mediation, but mediation is not binding, and parties do not always enter it in good faith. Trials can take 12 to 24 months just to reach opening statements. Arbitration often lands in between, with relaxed rules of evidence and procedure, though it is not cheap since you are paying both your attorney and the arbiter.
Regardless of which path the agreement chooses, make sure it includes expeditious provisions and incentives for parties to bargain in good faith.
Valuation is often an afterthought, which is a mistake. If a member wants out, how do you determine the value of the business? A formula based on revenue? A full business valuation? What happens if the partners cannot agree on the expert? A common solution is for each side to pick an expert, and those two experts pick a neutral third. Whatever mechanism you choose, it needs to be in writing before there is a dispute.
The AI Elephant in the Room
Yes, you can generate an operating agreement using AI in minutes. And frankly, it will often be pretty good. Better than a random template from ten years ago.
That is not the issue.
The issue is not whether AI can draft a document. It is whether that document reflects your specific deal structure, your state’s legal nuances, your tax strategy, and your long-term plans and potential conflicts. AI is excellent at producing general language. It is not great at anticipating the exact ways your business relationship might break down or evolve. It also does not sit in meetings, hear your intentions, or ask, “What happens if this goes sideways?”
We are not anti-AI. We use it too. But we treat it as a starting point, not the final product.
Operating Agreements
If you are a single-member LLC or if your business partner is your spouse, this information might not apply.
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