Operating agreement

Reading a sponsor's operating agreement, clause by clause

When a sponsor hands you an operating agreement, it is already written, and it was written to protect the sponsor. This is the clause-by-clause analysis of the document you are being asked to sign, read from both chairs: what each clause does for the sponsor, and what it costs you.

Writing your own operating agreement and reading one a sponsor hands you are opposite problems. When you write it, every clause is a choice you make. When a sponsor hands you one, every clause is a choice already made, and made by the person on the other side of the deal. The document is not neutral. It was drafted to protect the sponsor, and the clauses that matter most are the ones a passive investor skims: who controls the deal, who gets paid first, what happens when someone stops funding, and who bears the loss when it goes wrong.

This page reads that document clause by clause, from both chairs. For each provision, the question is the same: what does it do for the sponsor, and what does it cost you. The underlying articles live in the syndication pillar, because that is where a sponsor’s operating agreement is most often encountered, but the analysis is the same for any promoted deal where one party runs it and the others fund it.

The operating agreement a sponsor hands you is finished. Your only leverage is reading it before you sign, because after you sign, the document is the deal.

Who controls the deal

The control clauses decide how much power the sponsor holds and how little the investors keep. Read these first, because they govern everything else: an investor who cannot vote, cannot remove the sponsor, and cannot see the books has no way to enforce any other term.

Manager authority and major decisions What the sponsor can do without asking anyone, and the short list of things they cannot. LP voting rights and consent thresholds The votes you actually hold, and the ones set so high they are theoretical. Removing the sponsor Whether you can fire a sponsor who goes bad, and at what threshold. Amendment rights Who can change the agreement after you have already signed it. Information and reporting rights What you are entitled to see, and how sponsors quietly narrow it. Capital calls The demand for more money on the deal's worst day, and whether you can be forced. Dilution and default penalties What a capital call you cannot meet does to your ownership stake. Additional-capital rights and pay-to-play How follow-on money reshuffles ownership, usually against whoever cannot follow. Reserves and the capital account The accounting that tracks what you are actually owed and when.

Who gets paid, and in what order

The economic clauses are where the sponsor’s upside and the investor’s cost are the same number read from opposite sides. Every tier, every fee, every split is a place where the deal’s profit is divided, and the division was written by the party taking the promote.

The preferred return The return you are promised before the sponsor shares in any profit. The promote (carried interest) The sponsor's share of the upside, and exactly what it costs you. The waterfall, tier by tier The order in which every dollar is paid out, top to bottom. The catch-up provision The clause that can hand the sponsor a disproportionate slice right after the pref. Return of capital vs return on capital The distinction that decides when your money actually comes back. Clawback provisions Whether an overpaid sponsor has to give it back, and whether you can collect. Sponsor fees The fees that get paid whether the deal works or not. The GP co-invest How much of the sponsor's own money is actually at risk beside yours. European vs American waterfall Whether the sponsor is paid deal-by-deal or only after you are made whole.

Who bears the loss, and who is protected

The protection clauses decide what happens when the deal goes wrong: how much the sponsor is shielded from liability, who pays their legal bills, and how far their duties to you have been waived. These are the clauses that determine whether a bad outcome leaves you with a remedy or with nothing.

The standard of liability How much has to go wrong before the sponsor is actually on the hook. Indemnification of the sponsor When your own capital pays the sponsor's legal defense. The fiduciary duty waiver and its limits How much of the duty owed to you has been contracted away. Conflicts of interest The sponsor's other interests that compete with yours.

The bottom line

The operating agreement is the single most important document in a deal you do not control. It was drafted to protect the sponsor, and it is finished by the time you see it. Read the control clauses first, because they decide whether any other right is enforceable. Read the economic clauses knowing every favorable term for the sponsor is an unfavorable one for you. Read the protection clauses to learn what remedy you have if it fails. And read all of them before you wire, because your only leverage is the signature you have not yet given.