When starting or expanding a restaurant in the form of a partnership, one of the most important first steps to take is to consult with a business attorney to draft operating agreements everyone involved in the venture agrees to. Unfortunately, this very important step is often overlooked by new business owners, as they are busy getting their operation up and running and may want to cut down on what they see as unnecessary costs (such as attorney’s fees).
While skipping the operating agreement may not seem like a big deal, or something that can always be taken care of later at a more convenient time (hint: that day will likely never come), the agreement covers a variety of critical tax and legal issues that restaurant owners and operators must be aware of. For example, most operating agreements will cover profit and loss allocations for tax purposes, capital calls and capital distributions, management duties and obligations, possible restrictions for the sale of one’s interest in the partnership, and a whole host of other tax related provisions that I won’t bore you with in this blog. The bottom line is, the time to iron out these issues is before the business is operational, and while everyone is happy and friends. Not a few years down the road when some type of dispute or disagreement inevitably arises, and there is no legal document to look to in order to resolve the issue.
Partnerships can be a great entity through which to structure a restaurant operation, for a variety of reasons. They are extremely flexible, allowing for allocations of profits and losses in almost any manner that the owners see fit. As many restaurants lose money in the early years, partnerships often allow owners to take these losses to help offset their tax liability in these years, without necessarily fronting a lot of cash. Since many restaurants finance their equipment and buildout costs, the debt basis created by these liabilities can allow for losses to be taken advantage of from a tax perspective. Without a well drafted operating agreement however, these advantages can be partially or entirely lost to the business owners.
If you are thinking of starting up a new restaurant or franchise, or if you have an existing operation but never got around to that pesky operating agreement, reach out to your trusted tax or legal advisor and get it taken care of. You’ll likely be glad you did.
Austin M. Bradley, CPA