A Limited Liability Company’s (LLC) operating agreement may contain any provisions relating to:
- the company’s business operations;
- the conduct of its affairs; and
- the rights, powers, preferences, limitations, or responsibilities of its members, managers, employees, or agents
An operating agreement is a critical component of forming an LLC. If your company’s operating standards are established in your operating agreement, they will take precedence over the default rules. The state-provided default rules are a one-size-fits-all proposition. The reality is that all LLCs are unique and it is not always in the business’s best interests to operate under the default rules. Voting rights, distribution of profits, contractual liability, minority rights, and expulsion of members are all examples of rights affected by default rules. With that in mind, here are four reasons to have a custom operating agreement drafted.
1. An Operating Agreement is Proof of Your Limited Liability Status
It is critical to safeguard your limited liability status, thus drafting an operating agreement can act as proof that your personal responsibility is limited if you are sued one day. This is especially crucial for single-member LLCs, which may be considered sole proprietorships if the formalities of an LLC are not fulfilled. A professionally established operating agreement is key in establishing the LLC as a distinct business.
2. An Operating Agreement Allows for Profit and Loss Allocations
The LLC’s owners also get distributive shares, which are shares of gains/profits and losses. Operating agreements often state that each owner’s distributive share corresponds to their proportion of ownership in the LLC. If other arrangements are needed, the LLC must adhere to unique allocations regulations. Furthermore, the operating agreement should include profit distribution criteria and income tax considerations since these areas will be very important to each owner’s operations.
3. An Operating Agreement Serves as Protection for Working Relationships
For LLCs with more than one owner, the operating agreement should additionally establish profit sharing and decision-making powers. When financial or management problems emerge, it is easier to turn to the operating agreement than to try to solve the situation when the owners may be hostile. An operating agreement can help you decide what happens to your business if one of your co-owners dies or becomes incompetent. Owners are frequently obliged to collaborate with the spouses of dead co-owners since they did not have a strategy in place via the operating agreement.
4. An Operating Agreement Allows the Customization of Voting Rights
Another item addressed in the operating agreement is voting rights. The operating agreement should describe how voting rights should be apportioned among members, in addition to establishing the outcome necessary for a vote to pass (majority vs. unanimity). This is often accomplished in one of two ways: 1.) each member’s voting weight is valued depending on the amount of interest in the firm, or 2.) each member receives a “per capita” or single vote. Each of these factors must be determined ahead of time since, while the LLC company structure allows for informal decision making, a formal vote may be necessary to address some difficulties.
Contact a Business Formation Attorney
There are many considerations that a growing business should think about when creating or modifying its operating agreement. It may appear like there is a lot of information to process, but working with an experienced LLC formation attorney will help you ease the burden and streamline the drafting process. You worked hard to build the business, and changing the operating agreement allows you some security and peace of mind, which both go a long way as an owner. Contact us to schedule a consultation to discuss your priorities and objectives. We serve clients in New York, New Jersey, and Florida. We would love to speak with you. Reach out by phone (718) 513-3588 or by emailing info@bzlawgroup.com.
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