The Importance of an Operating Agreement for Your LLC
Whether you are a sole proprietor or in a partnership, your LLC needs a formal Operating Agreement. Even if your state does not legally require you to have it, an Operating Agreement helps formalize your business relationships within your LLC, and clearly lays out the nuts and bolts of your business operations.
An operating agreement will:
- – Establish the role of each member
- – Define the percentage of ownership and shares for each member
- – Outline the rights and responsibilities of each member
- – Establish decision-making protocols
- – Determine what happens when a member leaves the business
Protecting Your Limited Liability
A well thought out Operating Agreement for your LLC can protect you and your business from unforeseen pitfalls. It lends credibility to your company and distinguishes it from a Sole Proprietorship or Partnership in the eyes of the law. If your company flounders and you end up in court, your Operating Agreement will reinforce your LLC status and serve to help limit your personal liability.
Establishing Decision-Making Hierarchy
No matter how much you try to keep everyone on the same page, when you deal with other humans, there are bound to be occasional differences of opinion about finances and management. Your Operating Agreement can outline how decision-making in your business will be handled. Since everyone agreed to the terms from the beginning, they will be difficult for any member to dispute.
Maintaining Your Rights of Ownership
Without a formal Operating Agreement, you could be subject to your State’s default rules of operation. Say for example there is a dispute and you decide to dissolve the business. Perhaps you invested your life savings in the business, while the other members of your LLC invested only a small portion of that amount. Without an Operating Agreement, the court could decide to distribute the assets of the business equally to all members, leaving you with the greatest loss. A formal Operating Agreement specifically states how profits and losses of the business will be distributed among individual members.
Details to Include in your LLC’s Operating Agreement
Your Operating Agreements should be highly detailed to cover all contingencies. This may seem unnecessary when you are starting your business and everyone is invested both financially and emotionally. Yet things can get messy, especially when money is involved, and you are better off to try to foresee problems and spell them out in your Operating Agreement, than to have to figure out how to handle them later.
Your Operating Agreement Should Include:
- Percentage of each member’s interest in the LLC: Ownership percentages are usually distributed in proportion to members’ capital contributions, but they may be divided any way the LLC chooses. Distributive shares are usually in proportion to ownership, but again it is up to the LLC to determine.
- Distribution of profits and losses: How much of the profits will be distributed each year to members? Even when profits are put back into the business, they count as income to the members for tax purposes. Will the LLC cover each member’s taxes related to the business? At what intervals will distributions be made to members?
- Responsibilities and rights of each individual member: Will all members be actively involved in the daily operations of the business, or will they act as investors or silent partners only? How much say will each member have in the LLC’s daily operations?
- Voting power of each member: Will each member’s vote carry weight in proportion to their interest in the business, or will all votes carry equal weight?
- Management structure of the LLC: How will the daily operations of the business be managed, and by whom?
- Meeting and Voting Rules: How often will members meet, and what protocols will be followed at each meeting. How will votes be taken?
- Provisions for sell-out, buy out, and member death or disability: Will other members have the option to buy out the shares of someone who wants to leave? Will their shares of interest be divided equally among remaining members? If a member dies or becomes disabled, can a family member assume their role and interests?
Clearly, drawing up an Operating Agreement for your LLC is no small matter. There are many considerations to be made, and everything needs to be spelled out in language that is not ambiguous or vague. The professionals at Windsor are ready, willing and able to help you sort out the details of your LLC’s Operating Agreement. We know all the ins and outs of starting a business, including the legal aspects. Don’t let you business falter because you failed to create a formal Operating Agreement.