Does Your Limited Liability Company Really Need An Operating Agreement?
The answer to this question is YES! Most of today’s small to medium sized business owners have chosen to operate as a limited liability company (an “LLC”). LLC’s are popular because they serve to limit the business owner’s liability for business debts and accidents. They also provide the business owner(s) a wide array of options on how they choose to be taxed on the company’s income.
Some of the biggest legal battles I’ve seen in my twenty-plus years were caused by the lack of an Operating Agreement; a poorly drafted one that was never updated with the company’s growth; and my personal favorite, one that was downloaded from the internet! In all seriousness, the internet can be a great thing, but relying on an internet form for your Operating Agreement is only good for litigators. The flip-side of that coin is that as a lawyer who spends more time than most in the courtroom, I’ve seen how a well drafted Operating Agreement withstands the test, and how a poorly drafted ones fail the test. This has pushed me to help clients draft LLC Operating Agreements that will help the company succeed and avoid litigation down the road.
When it comes to LLC’s, the biggest problem I see in my practice is that many of them don’t have an Operating Agreement. This happens for a number of reasons. The most common reason is that when the business is started, the owner(s) have a small budget and don’t know if the enterprise is going to succeed, so they minimize the amount of money they spend (including legal fees) until they find out if the business is going to be successful. Once it becomes successful, the business owner(s) are too busy to worry about that small matter called the “Operating Agreement” (think corporation By-Laws).
So as not to bore you with too much legalese I will give you the short version of what an Operating Agreement does. It governs the conduct of the owners of the LLC and how the LLC will be run. The Operating Agreement designates who may act on behalf of the company and the limit of their authority. It also defines the LLC member’s rights and duties under both the law and the LLC’s Operating Agreement. A good Operating Agreement will set out the voting procedure for important matters and the number of votes held by each member and/or owner. There are many, many more issues your LLC Operating Agreement can and should address. The bottom line is your LLC Operating Agreement should be specifically tailored to you, your partner’s and your business’ needs.
Some business owners find themselves in the position of having had no Operating Agreement for so long they are afraid to bring the matter up with their business partner out of fear of fighting over how they will divide power. There are a myriad ways to solve concerns such as these. The truth is every great business partnership needs outside help and perspective now and then. When it comes to solving these problems, the key is an experienced attorney that helps clients solve these kind of problems on a routine basis.
Most co-owners of a successful LLC want two things from an Operating Agreement. They want the right to buy-out their partner in the case of sudden illness, divorce, death or retirement, and they want to know in advance how much that will cost. I’ve seen a lot of Operating Agreements that have a hard number/price based off x number of years’ company revenue. Beware of the Operating Agreement that has a hard number/price and a pre-designated formula on how that price is calculated. Many LLC partnership interests aren’t worth buying fifteen years after the company started, or on the eve of the partner’s retirement. The price may also be too steep for the remaining partner to afford. Careful thought should be given to having a key-man life insurance policy in place. Another option is having each side choose a business valuator and average their two numbers to come to the price of the buy-out.
I hope this article has opened your eyes to the thought that needs to go into crafting an Operating Agreement for your business. Helping business clients achieve success is one of the most rewarding things about practicing law for me.
The information in this article is not legal advice, and you should not take any action based on information you find in this article without first consulting qualified legal counsel concerning the facts and circumstances of your situation. No attorney-client relationship is established by reading this article.