In this week’s blog post, Phoenix lawyer Mark Briggs explains the importance of a solid operating agreement in your business and outlines five things you need to include.
In a recent post, I described some of the benefits to forming a limited liability company, commonlycalled an “LLC.” I like LLCs, because they offer the structural flexibility of a partnership, as well as the liability protection of a corporation. However, just as a partnership requires a partnership agreement, an LLC with more than one owner (commonly called a “member”) should have an operating agreement.
So, just what is an operating agreement? It is a contract by and among the members of the LLC that lays out everyone’s rights and obligations. It is typically a long document—usually at least 20 pages—but it covers a lot of ground.
Not every state requires LLCs to have an operating agreement, but you would be crazy not to have one if your LLC has more than one member. I get calls all the time from LLC members who have no operating agreement in place—usually, they skipped out on drafting one up due to neglect, or to save money on attorney’s fees. Of course, by the time they call me, there is some dispute among the members that costs far more to resolve than the operating agreement would have cost in the first place. A good operating agreement won’t stop an unscrupulous business partner from trying to take advantage of you, but it will make it far more difficult for them to do so.
As for what should go into an operating agreement, it always is situation-specific, but should include at least the following areas:
- Each member’s percentage of ownership
- Each member’s rights and responsibilities
- How business decisions will be made, and by whom
- Who will manage the day-to-day operations, and how much discretion they will have
- How the LLC will allocate profits and losses, and distribute cash, to the members
- How members will resolve disputes amongst themselves
- How/when members can transfer their ownership interests to another member or a third party, including when a member dies, divorces, or just wants to leave the business
What else will go into your operating agreement is up to you (and, in some cases, your state’s laws), but you really should hire a lawyer to help, because these are complicated documents, and they’re pretty easy to screw up.
Did you ever create an LLC without an operating agreement and end up regretting that choice? Feel free to share your tale of woe, and be a warning to fellow entrepreneurs!
Photo credit: thetaxhaven