An LLC operating agreement is a legal document drafted when a new limited liability company is formed. An operating agreement serves as a contract between the members of an LLC to establish how the company will be managed and operated. It lays out the company structure, important procedures, and rules, while also establishing the rights and responsibilities of each member of the LLC.
What is an LLC Operating Agreement Review
An LLC operating agreement review is the process by which the members of the LLC or their legal representatives review the operating agreement to ensure that the document is free from mistakes, includes all necessary provisions, and represents the interests of each member and the company.
Conducting a review before implementing the operating agreement is essential because this document acts as a legally binding contract that will govern the business and dictate the actions of the members.
An LLC operating agreement serves the following vital purposes in a company:
- Establishes the rights, responsibilities, and relationships between the LLC members.
- Documents a set of rules and procedures that all members will be required to follow.
- Establishes voting rights and decision-making procedures within the company.
- Protects the members’ interests and ensures that every member is treated fairly.
For these reasons, it is common for an LLC to hire an attorney to review the operating agreement before implementing it into daily business practices. A business attorney who is familiar with LLC operating agreements will know what terms must be included and ensure that the agreement adheres to all state and local laws that govern LLCs and operating agreements.
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Pitfalls of an Operating Agreement for an LLC
An LLC operating agreement offers members many benefits, however, if not drafted and reviewed properly, an operating agreement can have significant consequences.
Some common pitfalls of a poorly drafted operating agreement include:
- Confusion over ambiguous terms. The terms and language used in the operating agreement should be clear and unambiguous. Every member should be able to read and fully understand each provision. Failure to draft a clear and detailed operating agreement can lead to confusion and disputes among members.
- Failure to address important issues. An operating agreement establishes the framework for running a company. It sets up rules and procedures for everything from daily operations, to profit sharing, to dissolving the company. If an important issue is left out of the operating agreement, it could cause a disagreement or confusion when an issue arises.
- Lack of protection for members. One of the key purposes of an LLC operating agreement is to protect members by outlining member rights, profit sharing procedures, and ownership transfers. If your operating agreement fails to include these provisions, members may not have adequate protection which could lead to disputes and possible litigation if left unresolved.
- Failure to comply with the law. All contracts are governed by applicable federal, state, and local laws. If your operating fails to adhere to any laws or regulations, the contract may be invalid and unenforceable.
While operating agreements can be essential to running a successful business, a poorly drafted operating agreement could cause a lot of serious problems. To avoid these issues, it is essential that you have your LLC operating agreement reviewed by a knowledgeable lawyer.
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What Should be in an LLC Operating Agreement?
The terms and conditions in an LLC operating agreement will vary based on the company, the number of members, and the industry, but each agreement should include key provisions.
Here are some common topics typically addressed in a standard LLC operating agreement:
- Company information. The legal name, address, and purpose of the LLC.
- Member information. Members names, ownership interests, and capital contributions.
- Management structure. An LLC can be member-managed, which allows all members to have authority to manage the company, or manager-managed, in which members appoint managers to handle day-to-day operations.
- Voting rights and decision-making. How voting rights are allocated among the members and detailed procedures for decision-making, meetings, and voting.
- Profit and loss distribution. How profits and losses will be distributed among the members based on their ownership interests or other agreed upon terms.
- Transfer of ownership interests : Circumstances under which members can transfer or sell their ownership interests including any restrictions or rights of first refusal.
- Dissolution and liquidation. The process for dissolving the LLC and distributing its assets upon dissolution.
- Management and member duties : The rights, responsibilities, and fiduciary duties of managers and members.
- Dispute resolution. Provisions for resolving disputes like the use of mediation or arbitration.
Operating Agreement vs. LLC Operating Agreement
An operating agreement and an LLC operating agreement are essentially the same document except that an LLC operating agreement is specifically tailored to meet the needs of an LLC.
A standard operating agreement can be used for any business entity like a sole proprietorship or a partnership. An LLC operating agreement will include language and provisions that are unique to LLCs like the way the business is taxed or how profits and losses are distributed among members.
While the names may vary, these documents serve the same purpose – to provide the owners of the company with a legal document that governs the operation of the business.
How Important is an Operating Agreement for an LLC
Operating agreements are an important formation document for an LLC and some states even have laws that require LLCs to have an operating agreement.
Even if it isn’t required in your state, your LLC should have an operating agreement for the following reasons:
- Protection of member rights. An LLC operating agreement provides each member with protection and ensures they will be treated fairly.
- Clear understanding of ownership and management. The operating agreement will lay out the framework for the management and day-to-day operations of the company. Each member will be able to refer to the operating agreement to fully understand their roles and responsibilities in the company
- Guidance for voting and decision making. Operating agreements should include voting procedures to outline how the members will make company decisions.
- Guidance for dispute resolution. A clear set of procedures for solving disputes among members with resolution practices like mediation or arbitration.
- Maintain limited liability protection. An operating agreement serves to help establish the LLC as its own legal entity. This will help maintain the limited liability protection offered by an LLC.
- Banking and finance. Banks and other lenders may require an LLC to have an operating agreement to open a business bank account or obtain business loans.
Should I Hire a Lawyer to Review my Operating Agreement?
Yes. It is always recommended to hire a lawyer to review your LLC operating agreement. A lawyer can ensure that the operating agreement is drafted correctly, free from mistakes, and covers all important business issues.
In addition, a lawyer will be familiar with the laws governing LLCs and operating agreements so you can rest assured that your operating agreements will be legally valid and enforceable.
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