A limited liability company (LLC) is a business structure that incorporates the benefits of both a partnership (or sole-proprietorship) and a corporation. Specifically, like a corporation, an LLC protects business owners against personal liability to satisfy business debts. An LLC, however, also provides the benefits of pass through taxation that is normally only afforded to sole proprietorships and partnerships. The liability and tax benefits are substantial, often making the LLC the preferred structure when forming a business. Most business owners, however, think they are all set once they file the articles of organization and often overlook the great importance of a having a strong operating agreement in place.
A well-defined operating agreement is paramount to shield a business owner’s personal liability from the liabilities of the business. Similar to the bylaws of a corporation or a partnership agreement, an operating agreements functions to outline the rules under which the LLC will operate.
An operating agreement for an LLC should contain clear, comprehensive, and transparent terms. Some of the common provisions include:
- Ownership Percentages and contributions;
- Member rights and responsibilities;
- Management system;
- Voting procedure and rights;
- Allocation of Profits & Losses;
- Distributions;
- Buyout/Sellout provisions;
- Death/Disability and ownership changes provisions; and
- Amendments & Dissolution
An LLC operating agreement is necessary to preserve and strengthen the owners’ limited liability in order to safeguard their personal assets. An operating agreement outlines the procedures governing the company’s financial operations and helps avoid management misunderstandings among the members. Because the financial situations of the members generally differ (ie. variations in initial contributions, investor vs. sweat equity partner, etc), it is also necessary to set out the amount and timing of the distributions to members in the operating agreement.
Most importantly, an operating agreement will help to preserve the limited liability status of the company by treating the business as a separate entity, which is especially important for single member LLCs. The lack of an operating agreement, or an overly broad operating agreement, may not protect the business owners from personal liability if a court looks to the business owners to satisfy the business obligations.
There are many uncertainties a small business owner will encounter when venturing out into business, however, the financial operations and management of the business should not be one of them. Having a comprehensive operating agreement in place that outlines the finances and the members’ responsibilities will avoid many problems and provide business owners with the assurance that their personal assets will not be looked to satisfy the business obligations and debts.
Please contact Basyuk & Klaproth for assistance forming your LLC and drafting your operating agreement.
