An Operating Agreement is a contract that is drafted, and agreed to, by the members of an LLC that lays out the rules for how the business is going to operate. Operating Agreements are not required under state law, but are very helpful and we highly recommend them to our clients in any multi-member LLC scenario. Here are four reasons why.
1. Death of a Member.
If a Member dies, the remaining Members may find themselves facing a situation where the deceased Member’s estate or spouse is now a business partner. Worse, in certain industries where professional certifications are required, the LLC may have to dissolve upon the death of a Member. However, with a well-draft Operating Agreement in place, the Members can address the mechanics of death, disability, and/or retirement in advance.
Many business disputes take place upon an owner’s departure. If a Member desires to leave an LLC, the remaining Members will likely desire to repurchase his/her interest because they will not want to pay profits to a non-contributing Member. Likewise, the departing Member is going to want to be paid fair value for his/her Membership interest before selling it back to the entity. Deciding what is “fair value” under the stress of the moment is probably not a good idea; however, the mechanics of how to handle the transfer of shares, including valuation, timing, and other logistics, may be addressed in advance in an Operating Agreement.
An Operating Agreement should set forth in clear terms whether the LLC is Member-Managed or Manager-Managed. It should also delineate what a Manager’s title is, what his/her role is, and how much latitude and control the Manager has with regard to running the day-to-day operations and the ability to make decisions on behalf of the business. For example, an Operating Agreement can address, up-front, whether a Manager has access to the bank account or can sign contracts that bind the entity.
4. Capital Accounts; Allocation of Profits & Losses.
The tax rules surrounding Membership interests, capital accounts, and the tax basis of the Members are very complicated. Therefore, it is essential that an Operating Agreement address how the LLC is handling and accounting for each Member’s capital account. Members are particularly interested, of course, in the allocation of profits and losses. Additionally, it is important for a Member to know how they will be treated if/when new Members are subsequently added. These items may all be addressed in a well-drafted Operating Agreement.
For assistance with Operating Agreements, or any other legal needs related to your business or estate planning, contact Fournier Legal Services for a free consultation at firstname.lastname@example.org or 860.670.3535.
Joe received his law degree from the University of North Carolina–Chapel Hill School of Law and his Accounting degree from the University of Rhode Island. He is admitted to practice law in Connecticut, Massachusetts, and Rhode Island, and he is a CPA. He is an Adjunct Professor and lecturer at the University level and has been a frequent speaker on business planning and legal matters.