I watched a partnership blow up over a $12,000 disagreement. Two investors, 50/50 on a 16-unit building. Both smart guys. Both experienced. But when one wanted to spend $12,000 on a new boiler and the other thought they should patch the existing one, there was no mechanism to resolve it.

No tiebreaker. No arbitration clause. No buy-sell provision. Just two owners with equal authority who fundamentally disagreed. The argument escalated for three months while the boiler got worse, tenants complained, and two units went vacant because the heat was unreliable.

By the time they finally replaced the boiler, the total cost of that $12,000 disagreement was closer to $38,000 when you added the lost rent, the emergency repair calls, and the legal fees they spent arguing about it.

Their operating agreement was four pages long. Downloaded from the internet. It covered profit splits and not much else.

What an Operating Agreement Is Supposed to Do

An operating agreement is the governing document for an LLC. It defines the rights, responsibilities, and relationships between the members. It isn't a formality. It's the rulebook for how the business runs, especially when things go wrong.

Most investors spend more time negotiating the purchase price of a property than they spend on the operating agreement that governs how they will own and operate it. That's backwards. The purchase price determines what you pay. The operating agreement determines whether you survive the partnership.

Here are the clauses that matter most, and the ones that most operating agreements either skip entirely or handle so poorly they create more problems than they solve.

Buy-Sell Provisions (The Exit Clause)

Every partnership needs a way out. Not because you're planning to leave, but because circumstances change. People get divorced. People die. People run out of money. People just stop getting along.

A buy-sell provision, sometimes called a buyout clause, defines how one partner can buy out the other. It should address:

Triggering events. What circumstances activate the buy-sell? Common triggers include death, disability, bankruptcy, divorce, material breach of the operating agreement, or a voluntary desire to exit. Define them specifically. "Material breach" means something different to every attorney. Spell out what constitutes a breach.

Valuation method. This is where most buy-sell clauses fail. How do you determine the price? Three common approaches:

Agreed value. The members agree on a property value annually and record it. Simple but requires discipline. If nobody updates it for three years, it's useless.

Formula-based. Value is determined by a formula, such as NOI multiplied by an agreed cap rate. This is my preferred approach for real estate. It's objective, market-based, and doesn't require annual updates. If the building has a $70,000 NOI and the agreed cap rate is 7%, the building is worth $1,000,000 for buyout purposes. Simple math. No arguing.

Appraisal. Each party hires an appraiser. If the appraisals are within 10%, you average them. If not, the two appraisers select a third appraiser and the middle value controls. This is thorough but expensive and slow. Two to three months and $5,000 to $10,000 in appraisal fees.

Payment terms. Can the buying partner pay in installments, or is it all cash at close? If installments are allowed, what are the terms? Interest rate? Duration? Collateral? Don't leave this undefined. A partner who's forced out shouldn't also be forced to finance their own buyout at zero interest for 10 years.

Right of first refusal. Before any member can sell their interest to a third party, the remaining members should have the right to buy it at the same price and terms. This prevents you from waking up one day to find that your partner sold his half to someone you have never met and don't trust.

Deadlock Resolution

The boiler story I opened with is a deadlock. Two members with equal authority who disagree on a material decision. In a 50/50 partnership, deadlocks aren't unusual. They're inevitable.

Your operating agreement needs a mechanism to break them. Options include:

Designated managing member. One member has final authority on day-to-day operational decisions below a certain dollar threshold. Decisions above that threshold require unanimous consent. This is the simplest solution. If I'm the managing member, I decide whether to spend $12,000 on a boiler. If the decision is whether to sell the building, we both have to agree.

The key is defining the threshold. In our agreements, the managing member has authority on any single expenditure under $10,000 without requiring approval. Anything above that requires a member vote. This covers 95% of operational decisions and prevents the deadlock scenario.

Mediation, then arbitration. If the members can't agree on a major decision, they submit to mediation first (non-binding, facilitated negotiation). If mediation fails, they submit to binding arbitration. This is slower than a managing member structure, but it works for partnerships where neither party wants to cede authority.

Shotgun clause (Texas Shootout). This is the nuclear option, but it works. Either member can trigger it at any time. The triggering member names a price for the entire property. The other member has a defined period (usually 30 to 60 days) to either buy the triggering member's share at that price or sell their own share at that price.

The beauty of the shotgun clause is that it forces the triggering member to name a fair price. If they price too low, their partner buys them out cheap. If they price too high, they're stuck buying at an inflated value. It self-regulates.

I have seen shotgun clauses end disputes in 48 hours that had been festering for months. The threat of the clause is usually enough. People get a lot more reasonable when they know the alternative.

Capital Call Mechanics

What happens when the building needs money and the LLC doesn't have enough in reserves? A capital call is when the members are asked to contribute additional funds.

Your operating agreement must define:

Who can issue a capital call. Usually the managing member, but sometimes a majority vote.

Notice period. How much time do members have to fund? I recommend 30 days for non-emergency calls and 10 days for emergency calls (structural failure, major system collapse, etc.).

Consequences of non-contribution. This is the clause that protects you. If a member doesn't fund a capital call, what happens? Common remedies:

Dilution. The contributing member's ownership percentage increases, and the non-contributing member's percentage decreases, based on the additional capital contributed relative to total equity.

Preferred return. The contributing member earns a preferred return on the additional capital before any distributions are shared.

Loan treatment. The contributed capital is treated as a loan to the non-contributing member at a defined interest rate, repaid from future distributions.

Forced buyout. If a member fails to fund a capital call, the other member has the right to buy them out at a discounted valuation.

Without a capital call clause, you're exposed. If your partner refuses to contribute to a necessary repair and the building suffers, you have no contractual remedy. You end up covering the cost yourself with no increase in ownership and no recourse except a lawsuit. And lawsuits in real estate partnerships cost more than boilers.

Manager Removal

If one member is the managing member (which is the standard structure in most real estate LLCs), the operating agreement must define how and under what circumstances they can be removed.

For-cause removal. The managing member can be removed for fraud, embezzlement, material breach of fiduciary duty, or conviction of a felony. This is non-negotiable. Every agreement needs this.

Without-cause removal. Can the non-managing members remove the manager without proving fault? This is more controversial. Managers don't like this clause. Investors do. The compromise I use is without-cause removal requires a supermajority vote (75% of membership interests) and a defined notice period (90 days). This protects the manager from knee-jerk removal while giving investors a path to replace an underperforming operator.

Transition provisions. If the manager is removed, who takes over? What's the transition timeline? Do they retain any economic interest? Does their ownership percentage change? Define this now, not when emotions are running high and lawyers are billing $400 an hour.

The Clauses Nobody Reads Until It's Too Late

Here's the pattern I see. Two investors find a deal. They're excited. They agree on price, splits, and strategy. They download an operating agreement template, fill in the names and percentages, and close the deal.

Three years later, something goes wrong. A disagreement. A cash shortfall. A partner who stops responding to calls. They pull out the operating agreement, looking for answers, and find four pages of boilerplate that don't address their situation.

Then they call an attorney. And the attorney charges them $15,000 to $30,000 to negotiate the same provisions they could have put in the agreement for $3,000 to $5,000 at formation.

This isn't a hypothetical. I have lived it. I have seen it play out on buildings I manage. The partnerships that survive are the ones with agreements that anticipated the problems before they happened. The partnerships that blow up are the ones that assumed goodwill would be enough.

Build the Agreement for the Storm

Write your operating agreement assuming that someday you and your partner will disagree on something important. Because you will. Not because either of you is a bad person. Because that's what happens when two people share ownership of a real asset with real financial consequences.

The time to negotiate these clauses is when everyone is excited and optimistic. That's when you get fair, balanced provisions. If you wait until there's a conflict, every negotiation becomes adversarial, and the only people who win are the attorneys.

Hire a real estate attorney who has drafted operating agreements for investment partnerships. Not a general practice attorney who "can handle it." Show them this list. Make sure every one of these provisions is in your agreement, tailored to your specific deal structure.

The operating agreement is the cheapest insurance you will ever buy. And unlike your property insurance, you will only appreciate it when you need it most.

We talk about this every week on the Freedom Fighter Podcast. Listen on Spotify, Apple, or YouTube. Or reach out at Tanner@TopTierInvestmentFirm.com.

Tanner Sherman is the Principal and Managing Broker of Top Tier Investment Firm in Omaha, Nebraska. He co-hosts the Freedom Fighter Podcast with Ryan of Avara Investments.

The Operating Agreement Clause That Could Save Your Partnership