7 Key Items to Include in Your LLC Operating Agreement
By Brett Melson
Tuesday, July 24, 2018
An LLC Operating Agreement expresses the fundamental understanding among its members of the how the company will operate as well as the members’ respective rights and obligations, including such issues as voting, ownership and management rights.
The Operating Agreement is to an LLC what the bylaws (and shareholders agreement) is to a corporation. The most important question that should be addressed in an Operating Agreement is: What is the relationship involved?
An Operating Agreement between two equal partners, both of whom will be involved in the day-to-day operations of the LLC, will look very different from that of a company with one founder providing sweat equity or an LLC with multiple financial backers.
7 principal considerations commonly addressed in an LLC Operating Agreement:
- Classes of Interests
For various business, legal or tax reasons, LLCs may issue classes of LLC interests. Different classes may have differing rights with regard to any aspect of an LLC’s business or operations, including economic rights, voting rights and rights to distributions from the company.
- Economic Rights & Distributions
The Operating Agreement may set forth how economic profits and losses are allocated among the members and how and when distributions will be made. The amount and timing of distributions can be set at management's discretion, required at established times or triggered by certain events. LLC Operating Agreements sometimes include both required and discretionary distributions.
The Operating Agreement may set forth how the LLC is managed. An LLC can be managed by one or more members; by a board of persons (composed of members and/or non-members); or by one or more appointed managers. Generally, management is responsible for strategic decisions and the day-to-day running of the business, subject to any predefined limitations.
Management-related provisions commonly found in an LLC Operating Agreement include:
- Appointment of the initial members of management.
- Procedures or triggers for removing or replacing management.
- The powers of management (frequently a broad list of permitted actions)
- Limitations on management’s authority, such as a requirement that members representing a certain percentage of interests (individually or in the aggregate) pre-approve certain actions.
- Fiduciary Duties
Parties in an LLC Operating Agreement can waive or otherwise modify the traditional fiduciary duties of care and loyalty that may otherwise be imposed by default, as opposed to in a corporation. The practical effect of fiduciary duties is the subject of a significant body of case law, and language in an LLC Operating Agreement can be a primary determinant of the outcome of litigation among members of the LLC.
- Raising Additional Capital & Admitting Additional Members
An LLC may require additional working capital in the future. The procedures for raising supplemental funds (either from existing members or by accepting new investors) are generally spelled out in the Operating Agreement.
- Transfer of Interest or Withdrawal from LLC
An LLC Operating Agreement often describes when, and under what conditions, a member may transfer his/her interest in the LLC, including for estate planning purposes. Similarly, the Operating Agreement may set forth the process and permitted circumstances under which a member may withdraw from the LLC prior to its dissolution; however, such a withdrawal, if permitted, is frequently subject to significant conditions and limitations.
Often, a permitted transfer or withdrawal will trigger a right of first refusal, permitting the other members to acquire the interest at issue on such terms as are set forth in the Operating Agreement.
An LLC Operating Agreement often states the events or votes which will trigger the winding up and dissolution of the LLC, and typically details how any LLC assets will be distributed after the discharge of all its liabilities.
Since the LLC Operating Agreement is the governing document in regard to how the LLC is owned, operated and maintained, it is a good idea to make sure it covers all matters that could come up throughout the life of the company.
As the LLC grows and adapts, so, too, can the LLC Operating Agreement. It can be changed or modified to suit the LLC’s growing or changing needs. Since the LLC Operating Agreement is not on file with the state of Delaware and therefore not part of the public record, it can be internally changed or altered at any time during the life of the LLC.
THE AUTHOR OF THIS BLOG ARTICLE IS NOT A LAWYER AND HARVARD BUSINESS SERVICES, INC. IS NOT A LAW FIRM. THE ARTICLE ABOVE IS NOT INTENDED AS LEGAL ADVICE AND SHOULD NOT BE TAKEN AS LEGAL ADVICE. THIS SHORT ARTICLE IS STRICTLY TO MENTION SOME ASPECTS OF DELAWARE’S CORPORATION LAWS AND/OR LAWS RELATING TO OTHER FORMS OF ENTITIES WHICH YOU MAY NOT BE FAMILIAR WITH. WE RECOMMEND THAT YOU CONSULT WITH A LAWYER BEFORE FORMULATING A STRATEGY WHICH WILL BE SUITABLE FOR YOUR SPECIFIC CASE.
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There is 1 comment left for 7 Key Items to Include in Your LLC Operating Agreement
Rick thurston said: Thursday, September 13, 2018
What happens when all parties of the LLC don’t agree with the opporating agreement?
HBS Staff replied: Friday, September 14, 2018
In order to change the terms of the operating agreement, it must be amended. This process can vary by state. In Delaware, amendments do not need to be filed with the state. Please feel free to contact us for more information.