How to Create an Operating Agreement for Your Limited Liability Company
If you have decided to form a limited liability company (LLC), one of the first things you will need to do is create an operating agreement. What is an LLC operating agreement? This document lays out the rules and regulations for your LLC. It can be for a single-member LLC or a multi-member LLC. In this blog post, I will discuss what goes into an operating agreement and how to create one for your business.
What is the function of an LLC operating agreement?
Operating agreements are key documents, especially when you have multiple members, and are used to outline how the company will manage its finances, and make functional decisions, including rules, regulations, or provisions that govern the relationship between the members. It will govern the company's operation and internal operations. An operating agreement differs from the Articles of Organization, the legal document filed with your state. The Articles of Organization detail who will be the Registered Agent, and provide other helpful information to the public. All operating agreements are private contracts negotiated and signed between the business owners.
Do I need an operating agreement for my LLC?
If you are forming LLC chances are that you need an operating agreement. Most states require that is the LLC has more than one member that a written agreement between the members is needed. Some states do have default rules that apply in the operating agreement is not created, but these rules may not be ideal for your business. You can always opt out of the default rules by creating an operating agreement that outlines how you would like your business to function.
In some circumstances it is not necessary to have an operating agreement. For example, single-member LLCs are not usually required to have an operating agreement in place. But, even if your state does not require it, having an operating agreement can still be a good idea. Certain institutions, such as the Small Business Administration or Banks may want to see an operating agreement before they will issue financing to your small business.
Another circumstance when you may not need an operating agreement is if you are electing S Corporation status. This is because S Corporations have to follow more formal rules and regulations. Rather than an operating agreement, an S Corporation will have Corporate By-laws instad.
Generally, an operating agreement is important for the internal operations of your organization, irrespective of the state. Operating agreements clarify the organization's business process, e.g. distributing profits and losses and which employees are responsible for ensuring the law. This agreement enables Multimember LLC companies to avoid disputes by using this agreement.
Benefits of having an LLC operating agreement
In essence, an LLC's operations agreement resembles an owner's agreement. The agreement contains information the membership thinks is useful and will help the operation continue smoothly. Operating agreements will typically have multiple provisions that govern the relationship among the business owners. Common provisions in an operating agreement include:
-Decision-making processes
-Voting rights
-Percentage of ownership interests
-Profit and loss distributions
-Buyout provisions
An operating agreement can also help you if you are ever sued. If your operating agreement is well written and adhered to, it can be used as evidence in court that the Partner's followed all the necessary requirements. This could protect the members in the event that a disgruntled member attempts to sue the company.
Ready to get started on your operating agreement? Call us today at 248-522-6272 to schedule your FREE consultation and get started today!
How do operating agreements work?
An LLC Operating Agreement works as a function of contract law. This means that the operating agreement is binding on all members as long as it does not violate any state or federal laws. The operating agreement should be in writing and signed by all members of the LLC. Once the operating agreement is created, it can be changed only if all members agree to the changes.
Since the LLC operating agreement is a contract, it is considered a private document and is not filed with the state or anywhere else. Rather it should be kept with other important corporate records.
Because Operating Agreements are a function of state law, it is important to have an operating agreement that complies with the law of the state in which your LLC is organized. Each state has different rules and regulations governing LLCs, so it is important to consult with an attorney familiar with the laws of your state. The terms of the agreement should be negotiated between the members and only signed once all members have come to terms with the contents.
All operating agreements should include certain basic information:
Company information
An LLC operating should include the company name and address. Sometimes, it may also include industries in which you operate and descriptions of services. Consider creating an organizational goal that defines the goals your business wants and how you intend to accomplish it.
Other Details
The operating agreement may also make provisions for transferability of Membership Interest, the different types of interest involved in the company, management of the LLC, and voting rules.
It is important to have an operating agreement because it helps you avoid disputes, protects you if you are ever sued, and ensures that your company complies with state law.
Membership Information
An LLC operating agreement will also include information about the member, including different classes of membership, ownership percentages, and voting rights. These terms can be helpful when looking to have different classes of investors or business partners. Without an operating agreement, your business could be managed in a way that is not beneficial to all members.
What should an LLC operating agreement include?
While LLCs have many similarities, no two operating agreements will be identical. Even if you own multiple LLCs, the company's terms will vary from entity to entity.
Some common provisions and articles in different LLCs include the following:
New members and exit rights
It is advisable to have a process for accepting new members in an LLC. In the majority of instances, a new membermay only be admitted after a vote of the membership. This is important to ensure that all members are in agreement with the new individual joining the company. Admission of new members is also important to ensure that member interest in the company is not diluted without consent of everyone involved.
The Membership provisions should also discuss situations when a member is looking to exit the company. Do you want to offer a right of first refusal? Should the member be required to give notice? What are the events that would trigger an automatic withdrawal?
Most LLC operating agreements grant the first refusal to an existing owner who wants to acquire outgoing ownership interests, so they retain close control. Oftentimes, the company will be the first party able to purchase the exiting member's shares, only after the company passes on the repurchase will other members have an opportunity to purchase the exiting member's interest in the business.
Member and manager information
Another big decision when forming your LLC is whether the company will be member-managed or manager-managed. Your LLC operating agreement should include information regarding each of its members, including the names and names of the managers and who will be the initial manager(s) of the company. The LLC operating agreement will also spell out how managers are chosen, the length of their term, and provide what powers the manager has.
The LLC can be governed by members or managers. When a member is governed, they collectively handle business activities throughout the year. When a management-driven company is formed, the members can elect a management member to manage the organization. The LLC operations agreement must clarify whether the LLC has members.
Voting and approval rights
Another provision that is necessary in an operating agreement is the voting rights for daily management and important milestones of the company. Voting rights do not have to be equal for all situations. Unless specified in the operating agreement, simple majority voting is the default in almost every circumstance. When reviewing an operating agreement, it is important to know when the Manager can act alone, and when there must be a member meeting to vote on certain actions. Many entrepreneurs want flexibility in changing their LLC operating agreement later if needed, which is why often many powers and not retained and left to the managers.
Additional provisions
Your LLC's operating agreement depends primarily on your specific business or business sector. Although not in every LLC agreement, there are other provisions that can be included in an operating agreement. For example, optional provisions include: what happens in terms of deadlock, transfer on death, anti-dilution provisions to name a few. LLC members can also decide on the limited liability status of managers and indemnification provisions if there is a Board of Managers making decisions for the LLC.
Dissolution
The Operating Agreement must also address the potential for member businesses to be dissolved. A common law requirement for a member to vote is that it triggers a dissolution proceeding. An LLC's termination is usually difficult because it includes a state filing, liquidation of assets, and payments to creditors, among other dissolution actions. Only after all creditors have been paid, do the members then distribute the remaining assets to almost the business partners based on ownership percentages.
Ready to get started on your operating agreement? Call us today at 248-522-6272 to schedule your FREE consultation and get started today!
Can I write my own operating agreement?
Can you write your own operating agreement? In short, yes you absolutely can. However, by having the operating agreement drafted by a lawyer, you are ensuring that the terms of the relationship between the partners is clear, which can help alleviate issues in the event of a dispute amongst the owners.
Operating Agreement vs. Articles of Organization
The latter two documents can be helpful in establishing a company. Nevertheless, the articles of organization, also called certificates of organisation, have been filed by the state for registration as legal business entities. The operating agreements are internally documented. Although this document is legally binding as the Statute governs the organization, this document isn't needed to file in the state.
After completing the operating agreement
After you have finished your operation agreement you don't need to make any other changes. Nonetheless, there are a few states where an LLC must submit an introductory document if it has been formed. Consult state legislation for specific requirements. The Secretary's website lists the requirements for LLCs in most states. The best idea to maintain an important document in your LLC includes your operating agreements. Take the operating agreements out and distribute copies to your LLC members.
How do taxes work with an LLC?
Your LLC tax classification determines the way you file federal income tax returns on your company. Find a tax attorney to determine which taxes best suit your organization's unique circumstances and needs. The uniform audit rules for partnership taxation are applicable. These rules are not applicable to individual LLCs or corporations. An LLC with 2 or more members can generally be considered a partnership for tax purposes. In that instance, the business pays no taxes but pays employment taxes and excisable duties. All partners report their earnings on their personal tax returns.
We can help you
Drafting a new operating agreement for your business can be a tall task. I have worked with multiple businesses to draft and negotiate operating agreements that work for the business and its partners. My no-nonsense approach allows you to consider all angles of your operating agreement to ensure it will work when needed.
Don't put off drafting your operating agreement any longer; call me today at 248-522-6772 to get started on protecting your business! Contact us today to get started!
