Five Important Things You Should Have in Your LLC Operating Agreement
Posted Wednesday, September 5, 2018 by Kim Sandher
While most states don’t require you to have an operating agreement (Washington is the one of the states that does not require it), one of the biggest mistakes people make after setting up a Limited Liability Company is not drafting an operating agreement. I’ve had many clients come to me after things have fallen apart and they don’t have anything in writing to resolve their issues and a lot of them end up in expensive litigation trying to resolve the problem. As you probably know, litigation can be very expensive. It’s good to address things you don’t want to think about and that are not at the top of your list when launching your business.
An operating agreement is the document that lays out the rules and understanding among the members of the LLC. It is like what the bylaws for a corporation are.
These are five important things you should consider putting in yours:
1. Ownership Interests: Usually ownership is based on how much each owner contributed when the company was started, but it’s still possible to split other ways. A lot of people make other arrangements. For example, an owner might get 30% of the company even though he or she only contributed 10% of the money to the company because they bring more experience, or will be bringing in more sales, or will be the only one running the business. Whatever the reason is, the operating agreement should clearly list out how much each owner interest is because it will affect important decisions for your company.
2. Management: The LLC can be managed by one or more members, by a board, or by one or more managers. Typically, management is responsible for the day-to-day running of the business and for strategic decisions. Your operating agreement should lay out how management is selected, what triggers removing or replacing management, what procedures should be followed, what powers management has, and any limitations to management.
3. Sharing of Profits and Losses:
Usually sharing in profits and losses is done according to the percentage owned. For example, if you own 30% of the company, you would get 30% of the profits and/or 30% of the losses. If a member is an individual, the amount they receive in profit or losses is typically what they’d report on their personal income tax. The percentages may be different than ownership interest because of tax considerations. It’s good to lay all of this out clearly in an agreement.
4. Member Changes: Laying out how a member may exit the business, sell their share, or what happens when a member dies will save you the hassle and stress of figuring it out when it does happen. You might want to give the remaining members the option to buy the exiting member’s share and lay out how the business will be valued. You may want to also address what happens when a member files for divorce or bankruptcy.
5. Dissolution: You should address the steps that should be taken to dissolve the LLC and how the assets should be divided and how debts should be paid.
Since this is one of the most important documents your business will have, it is always a good idea to have an attorney review your document even if you’ve drafted it yourself. Your lawyer will look it over to address any legal issues with the drafting and/or point out anything you may have missed. You should also keep this document updated to address any changes in the business.