Among the advantages of setting up your company as a limited liability company (LLC) is the simplicity of few statutory compliance requirements and the peace of mind that your personal assets are protected. Now that you’ve decided that an LLC is how you want to set up your company, you must prepare and file your articles of organization with the state that you’ve decided to establish your LLC. In addition, you should also consider setting some internal ground rules for how you manage and run your LLC. The document that you do that is your company’s Operating Agreement.
The Operating Agreement sets forth, among other things, the manner of operation of the business; how the members of the LLC will make decisions; how the profits or losses of the LLC will be allocated. Although some states don’t require you to have one, you should definitely consider it. An Operating Agreement provides evidence that your personal and business affairs are separate and can go a long way toward helping avoid misunderstandings, arguments, and all-out battles among business partners.
A LLC operating agreement should typically address the following points:
1. Percentage of Ownership/ Distribution of profits and losses
An Operating Agreement should indicate each members’ percentage of ownership according to the percentage of the total funds (capital contributions) they invested into the business. Although the funds invested is the primary manner of allocating percentage of ownership, that may not always be the case. For example one of the members of the LLC may be providing labor and services to the company in exchange for ownership percentage. Your Operating Agreement should specify the percent of ownership to make it completely clear.
LLCs offer flexibility in how you can split your business profits and losses. While often the percent of profits individual members get is directly related to ownership percentage, you might decide a different arrangement would be appropriate. Your operating agreement should spell that out, so there’s no confusion.
2. Your LLC’s Management Structure/Members’ Roles and Responsibilities
When completing your Articles of Organization, you must choose to set it up as either member-managed or manager-managed. When member-managed, the owners run the company day in and day out, actively making decisions and conducting business. If you opt to have your LLC manager-managed, you elect a manager to run the business. It’s important to specify the roles and responsibilities of your LLC’s members (and manager, if applicable), so everyone knows what they should be doing and the authority they have.
3. How Decisions Will Be Made
For decisions that require a decision by members, the Operating Agreement should specify if a majority or unanimous vote of members is required. In many states, the statutory default for voting power in LLCs is proportional to ownership percentage. If you would like a different manner you can modify it so it makes sense for your situation.
4. What Happens If A Member Wants Out
In the event any member decides to exit the business, you need to address what will happen to their ownership interests. Having included this scenario in your LLC operating agreement will eliminate any issues when someone leaves for personal reasons or dies.
For example, you might stipulate that if a member chooses to leave voluntarily, that member must offer his or her ownership interest to the other members before offering their membership interest to a third party. If a member passes away, you can document that the transfer of his or her ownership interest to a third party requires approval by the other members. It is also recommended that the Operating Agreement also describe what should happen if a member files for bankruptcy or gets a divorce.
5. What Happens If You Want to Close Your Business
The dissolution of your new business wouldn’t be on top of your mind when launching your business, but it’s wise to think about the unthinkable just in case it does become an unwelcome reality. Your Operating Agreement should include the steps that should be taken when dissolving the LLC and how your LLC’s assets should be divided after its debts are paid.
Business owners should treat their Operating Agreements as living documents. Events occur that affect your business and you should update your LLC Operating Agreement to reflect modifications in the roles of members, changes in how you’ll want profits distributed, a new business address, etc. By making sure your Operating Agreement reflects your current situation, you’ll be better prepared to handle any questions or misunderstandings that arise regarding how your company should be run.
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Bretz, Flynn & Associates clients tend to be entrepreneurial and range in size from family offices to large corporations. Bretz, Flynn & Associates provides counsel at every stage, from formation through, sale, disposition or succession to later generations. Should you need any assistance to ensure your business remains successful and profitable, contact Bretz, Flynn & Associates today at (815) 740-1545 today!