An operating agreement for your LLC serves as the roadmap for how your company will operate. While there is no such thing as an “unimportant term,” here are the four that I think are the most important for ALL companies to address:
1. Your LLC’s name. Yes, this seems strikingly simple. Which is why it needs to be mentioned. Let’s say we are starting a new company that we want to call “ABC’s Home Improvements, LLC.”
- Often, when setting up a business, the business is set up first with the State Corporation Commission in Virginia (“SCC”) or similar governing body if in another state, by filing what are called Articles of Organization. There, you enter the official name of your company into the state’s records and are also able to confirm that it is distinguishable from other companies. You have now successfully have completed step one to set up “ABC’s Home Improvement, LLC.”
- Next, the company moves on to setting up their Operating Agreement. But when drafting, maybe the Articles of Organization are no longer in front of them, and they do not immediately recall the name selected with the SCC. So, they draft and sign a document entitled “The Operating Agreement of ABC House Improvement, LLC.” Close enough, right?
- Wrong. “ABC’s Home Improvements, LLC” is a different company name from “ABC House Improvement, LLC.” The name of the company contained in your operating agreement should match EXACTLY what is in the state records to avoid problems later. Further, when you obtain an EIN number from the Internal Revenue Service, you should likewise ensure an exact name match.
2. Membership. Regardless of how many members your LLC has, the Operating Agreement should always list the names of all of its members as well as a measure of how much of the company each member owns, particularly if profits and losses are to be distributed based on ownership percentages. When applying for a loan, for example, the bank will be reviewing the operating agreement closely for this information.
- Additionally, the agreement should tackle the subject of how new members are added to the company. While the possibility of adding owners is often exciting and it means the company is growing, the addition of a member also has the possibility of diluting the interests of the other members. This is a good place to address, for example, the contribution a new member would need to make in order to become a member of the company, or whether there should be a separate structure for new members who are serving as silent investors.
3. Governance. Now that you have properly set out the name of your company and the identity of the members, this is the critical component of your operating agreement. Governance boils down to how your company operates. For an LLC, it can be either member-managed, whereby all members make decisions and manage the company day-to-day, or manager-managed, whereby a manager is appointed to operate the company. An Operating Agreement should discuss questions like: Who is the manager? What decisions can they make? What sorts of decisions need the approval of the members? Are there any decisions that should require unanimous consent? Is a meeting required?
- Clearly outlining the duties of the members and/or manager in the Operating Agreement allows for all to know and understand what their duties are. Clear delineation of everyone’s tasks and roles ensures a smoother business operation.
4. When It’s Over. A good operating agreement should not only address how the company is run today but also address an exit strategy for the future. What happens if one member wants to leave or in the event of their death? A well- drafted operating agreement will address this by, for example, allowing the other members that opportunity to buy out the departing member’s interest in the company.
- Or what happens when the members are simply ready to wind up and dissolve the business? How will assets be distributed and debts paid? An operating agreement should also address the winding down of business operations.
By addressing these four topics, your operating agreement will continue to serve as the roadmap you need as you navigate the day-to-day of your business as well as its future. If you need assistance in making sure that your operating agreement covers these important terms (and others!), give the attorneys at Way Law a call today!