Understanding LLC Operating Agreements

Understanding LLC Operating Agreements

Limited Liability Companies, or LLCs, have gained huge popularity in recent years as an easy, flexible, and secure way to form a business. While there is no one-size-fits-all solution for every business, and LLCs do have some drawbacks to consider, there is a good chance that this structure will be a nice option for your needs.

One of the key components of forming and running an LLC is the Operating Agreement. If you are new to the LLC world, or if you have formed one before but need a bit of a refresher, this article is sure to help you negotiate the Operating Agreement requirement successfully. We’ll go through what it is, why it matters, and what key components it needs to include below. Of course, if you need any assistance from a professional team when forming your new business, take a moment to reach out to Fisher Stone to get started.

What is an LLC Operating Agreement?

An LLC Operating Agreement is a legal document that serves as a blueprint for how your business is going to be managed. This is different than something like a casual business plan that you might put together when you are just starting to form the idea of what you are going to do with your company. There are specific, legally binding components that will be included in your Operating Agreement, and we’ll get into those details a little later on this page.

While they are not required in all states, LLCs that are formed in New York do need to adopt a written Operating Agreement. You may choose to have this document in place right from the start, or you could enter into the agreement within 90 days of officially forming the LLC through the Articles of Organization. Although it is necessary to adopt such a document, you do not have to file it with the State.

Why Does This Document Matter?

There are a number of different reasons why you’ll want to spend plenty of time and effort getting your Operating Agreement just right. This is your chance to establish the terms of your new business in a way that will allow you to operate as you and your partners see fit. Rather than taking for granted that things will always go smoothly – they rarely do – you can use this agreement to outline how the process will play out when issues or disputes arise.

Some of the benefits of having a sound Operating Agreement in place include the following –

• Legal protection. One of the biggest reasons to form an LLC in the first place is to provide yourself and your business partners with some legal protection in the case of a lawsuit or some other issue that may come up down the line. You want to have the LLC as a layer of protection between your personal assets and those of the business. Having your Operating Agreement in place is a big part of making sure this protection holds up in court should it be challenged.
• Establish management processes. No matter how many members are going to be a part of your LLC, you need to make sure that everyone has a clearly defined role – and that also happens in this document. It’s not good enough to just agree with a handshake on who is going to do what for the business. Put it in writing so you can dramatically cut down on the likelihood of disputes and confusion later on. Even if everyone has the best interests of the LLC in mind when getting started, defining roles will help to avoid messiness. You can also use this opportunity to outline what happens when one of the members of the LLC wants to leave the company.
• Outline dispute resolution. It’s possible that you will run into some kind of drama with fellow LLC members along the way. That’s not the outcome anyone is hoping for at the start, of course, but it does happen – and it’s far easier to sort it all out if you can point to the process outlined in the Operating Agreement. This is where you can place requirements for certain types of resolution methods, such as arbitration or mediation.
• Getting investments. Some LLCs are formed with the idea that they are going to seek outside money to grow the operation. If that is part of your plan, you’ll surely want to have a carefully crafted Operating Agreement in place. This is one piece that will not only show the potential investors how their money will be handled, but it will also give them confidence that you are running an organized, professional operation.

A Few Key Components

It should be stated from the start that this section is not meant to be a comprehensive look at everything that needs to be included in your LLC’s Operating Agreement. The document you approve to serve in this role needs to be custom to your situation and needs to address all of the important points that relate to how you are going to do business.

With that said, there are some components that are almost certainly going to be seen in the Operating Agreement, so we’d like to outline them here for you to review.

• Basic information. As a starting point, you will need to have the full legal name of the business, the location of the business, details like the date the business was formed, and the registered agent who is going to receive all legal documents (this can be an owner or a representative such as a lawyer).
• Member information. In the world of LLCs, owners are referred to as “members”. So, all members of the LLC need to be listed, along with the capital that they have contributed to the project. At the same time, you’ll want to list out the percentage of the LLC that is owned by each member, and the voting rights that those members hold.
• Management structure. This is going to be one of the more involved sections in the Operating Agreement. Here, you can explain things like what roles and responsibilities each of the members holds, including how they are involved in day-to-day operations. Also, this is a good place to outline the decision-making process, including how any votes will be conducted and what happens in the case of a tied vote. You will also need to hold periodic meetings as part of operating the LLC, and the guidelines for how those meetings are scheduled and held can be put here, as well.
• Profit and loss distribution. Once the LLC starts to operate, there is sure to be a flow of money that goes in and out of the business. When you add it all up over a given period, that will leave you with either a profit or loss – and your Operating Agreement should detail how those gains or losses are handled. It’s common for profits to be distributed along the lines of ownership percentages, but each LLC is free to structure those distributions in whatever manner they see fit. Also, tax matters can be addressed here, as you may have a few different options for how your LLC is going to be taxed once it starts to make money.
• Membership changes. It’s quite likely that you will experience membership changes over the life of the LLC. That could mean welcoming new members into the fold, having members withdraw, or even having to expel a member for a specific reason. Detailing how membership changes are going to be dealt with in the future will go a long way toward steering clear of power struggles and other stressful issues.

Avoid These Common Mistakes

A good Operating Agreement for your LLC is worth its weight in gold. Unfortunately, not all Operating Agreements are good ones, and sometimes, the document that an LLC uses in this role proves to be practically useless.

One of the biggest problems here is vague writing. Using language that is open to interpretation and is hard to enforce will leave you with nothing but trouble later on. Everything in the agreement should be as specific and direct as possible. You also need to make sure that the document complies with state laws governing LLCs, or the whole thing could be thrown out if you ever need to use it in a legal conflict.

It’s also important to update your Limited Liability Company Operating Agreement regularly. When changes occur, such as a change in membership or how the business operates, update the document as quickly as possible.

Turn to the Team at Fisher Stone

If you are getting ready to form an LLC in New York, or if you are just starting to think about forming a business and you want to figure out what structure is best for you, Fisher Stone is here to help. We’ll be happy to go over the details of this situation with you, getting to know your business plans and advising you on how to structure it for long-term growth and stability. Take a moment now to get in touch and learn more.