Preparing an Operating Agreement for your LLC

No other document is as important to your LLC’s operation as its Operating Agreement. Without an Operating Agreement you have to depend on existing state law or a lawsuit to operate or resolve problems in your LLC, despite what you may have agreed to verbally with the other owners.

Most state LLC laws say that they will defer to an LLC’s Operating Agreement, as long as there is one. Without the Agreement, you’re stuck with state law. This can be very problematic for passive income businesses, especially those who have made different profit distribution arrangements. But it can be a problem for all kinds of businesses. For example, you might have retained someone to act as the LLC’s Nominee Manager, so you can stay private. But if you haven’t clearly laid out what role the Nominee Manager plays, and how that position can be managed or altered, you could wind up in a situation where the Nominee has full control over your business. An Operating Agreement can also set the ground rules for other things, like how you resolve differences between Managers or Members, and how you buy someone out (or are bought out) of a business situation that isn’t working anymore.

A properly drafted and signed Operating Agreement can also help to preserve your LLC’s liability shield. In fact, the more detailed and thought out the Agreement, the better it is as a piece of evidence demonstrating that you intended to create a true business and are operating as a true business.

Here are some of the other things that you should expect to see in your LLC’s Operating Agreement:

Confirmation of the structure set out in the Articles (i.e., Manager or Member-Managed),

Names the original managers or managing members, and sets out the structure by which these individuals may be appointed or removed. Instructions on how and when profit distributions are made

Tax classification of the LLC

Confirmation of the level of control managers have over the LLC’s operations

The type and amount of checks and balances built into the business structure (i.e., when manager decisions must be approved by members, and the number of members required to approve these decisions)

How member and/or manager meetings may be called and conducted

When managers or managing members may ask the LLC’s members to contribute additional cash to the LLC, and what happens when a member cannot or does not wish to make additional contributions

The percentage of member votes required to do certain things, like changing the terms of the Operating Agreement, changing managers, changing members, selling membership interests

The rights and responsibilities of each member of the LLC

The circumstances under which a member may be bought out by the other members or by the manager (i.e., in the event of a member’s bankruptcy, divorce, or legal proceedings being taken against them that could lead to a charging order or an order to liquidate LLC assets)

How members may sell their interests in the LLC; whether there is a right of first refusal owed to the LLC and remaining members; how the sale price is to be calculated; and whether an outside purchaser has the automatic right to become a full voting member, or whether they must be approved by the other members first, and how that procedure will be carried out

The percentage of member votes required to approve the closure of the LLC and the liquidation and distribution of its remaining assets

A dispute resolution procedure

Dispute resolution is another essential element of your Operating Agreement. In many cases LLC owners decide to forego litigation in favor of binding arbitration, which is a quicker and cheaper method of resolving disputes. State laws don’t automatically prohibit litigation though, so if you don’t have an Operating Agreement that specifically states members cannot resolve disputes in court, that’s exactly where you might find yourself.

There are many variables when you’re structuring a business. That’s why it’s hard to go through a quick-service website. Unless you talk to someone who’s got some knowledge and experience on both the tax and the legal side, it’s hard to know what you don’t know. And that can leave you vulnerable.

Got questions? Contact us! We’re here for you.

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