Key Provisions of an LLC Operating Agreement
When forming a multi-member Limited Liability Company (LLC) (i.e., an LLC with more than one owner), one of the most critical steps is drafting a comprehensive LLC operating agreement. This legal document sets the foundation for the business’s operations and management, and understanding its common provisions is crucial for any entrepreneur. In this blog post, we delve into some of these key provisions of an LLC operating agreement to help you navigate this important aspect of your business.
LLC and LLC Operating Agreement Basics
First, it’s important to understand what an operating agreement and LLC are not. An operating agreement is not a partnership agreement. Even though a multi-member LLC will most likely be taxed as a partnership, an LLC is not a partnership. A partnership is a separate type of business arrangement, which may or may not be documented by a partnership agreement and may or may not require filing formation documents with the state where the partnership is located.
An LLC is also not a corporation, so it does not have shareholders, a Board of Directors, and in many instances, does not issue certificates representing an ownership interest. In addition, unlike a corporation, the owners of an LLC (called members) are not W2 employees for tax purposes, unless the LLC elects to be taxed as an S-Corp or C-Corp.
With that in mind, below are some key provisions in an LLC operating agreement.
1. Membership Interests and Capital Contributions
The operating agreement should clearly define each member’s ownership percentage, often based on their capital contributions. These contributions can be in the form of cash, property, or services, and the agreement should specify the value of each type. It’s vital to detail how additional contributions will be handled and the implications for the members’ ownership percentages.
2. Distribution of Profits and Losses
A fundamental aspect of the agreement is outlining how the LLC will distribute profits and losses. Typically, this is done in proportion to each member’s ownership interest, but alternative arrangements can be made. The agreement should also specify the timing of these distributions, whether monthly, quarterly, or annually.
3. Management Structure and Voting Rights
Multi-member LLCs can be managed by members (member-managed) or by appointed managers (manager-managed). The operating agreement should state which structure your LLC will use. Additionally, it must outline the voting rights of members, which often correlate with ownership interest, and detail the decision-making process for various business affairs.
4. Transferability of Membership Interests
This section addresses restrictions on the transfer of membership interests. It typically includes provisions for what happens if a member wants to sell their interest, dies, or becomes incapacitated. These provisions help ensure stability and continuity for the LLC.
5. Dissolution and Winding Up
The agreement should specify the conditions under which the LLC may be dissolved. This includes the process for winding up the business’s affairs, distributing assets, and handling liabilities. Planning for the end of the business is as important as planning for its operation.
6. Dispute Resolution
To avoid costly litigation, the operating agreement can include a dispute resolution clause. This might mandate mediation or arbitration as the first steps in resolving conflicts among members.
Conclusion
A well-crafted operating agreement is vital for any multi-member LLC. It provides a clear framework for operations and management, helps prevent misunderstandings among members, and ensures compliance with state laws. While this post covers the basics, every business is unique, and it’s always advisable to consult with a legal professional to tailor your agreement to your specific needs and circumstances.
For personalized advice and assistance in drafting your LLC operating agreement, please contact the corporate and business lawyers Brown & Blaier, PC.
