Operating Agreements: Four Essential Considerations

By Joe Fournier

Most LLCs are single-member LLCs, whose members are individuals. However, many of our clients, and those requiring the majority of the attention with regard to legal services, are two-member LLCs. It is a prudent business, legal, and tax strategy for these dual-member LLCs to have solid operating agreements in place to address some of the issues that could later derail a promising business relationship. Accordingly, our experience has shown that it is essential to address the following four provisions in your operating agreements.

1. Management.

It is wise to list out the Managers’ respective duties. Do both members have the authority to manage, direct, and control the normal business operations? Will each Manager have the actual and apparent authority to bind the company? Will both have full access to the bank accounts, and check-writing privileges? These are important items to consider before entering into an Operating Agreement.

2. Disagreements.

Everything seems great today, but at some point, you will have disagreements with your business partner(s). An Operating Agreement should set forth how disagreements between Members will be resolved. For example, some Operating Agreements give a tie-breaking vote to a neutral third party, such as the LLC’s attorney or outside accountant. Others provide a mechanism for mediation or arbitration. In some situations, the default option may be a dissolution, although we typically advise this as the last resort. Regardless of how you decide to address, setting these rules now can save the business a lot of time, energy, and stress down the road.

3. Transferability.

The issue of whether Members should be allowed to sell or gift their membership interests is often highly negotiated. In most cases, we advise that no Member may transfer his/her interests without first offering them back to the remaining Member(s). Likewise, it is wise to consider what would happen if a Member dies. You probably did not enter into business with the expectation that your partner’s spouse would someday be your business partner. Accordingly, we typically advise our clients to require the fiduciary of a deceased Member’s estate to offer the deceased Member’s interest back to the company.

4. Valuation Methodology.

You may have already figured out that many of the challenging issues facing LLC members will involve the valuation of a membership interest. Accordingly, it is prudent to insert a valuation mechanism now in an attempt to minimize disagreements and costs in the future. There are many ways to address a valuation, but some of the ones we prefer to employ are: annual valuation from the LLC’s outside accountants; a pre-determined formula, i.e., 4X EBITDA; reference to a neutral third party, upon whom both Members must agree.

For assistance with your LLCs operating agreement, or any other legal matters, contact Fournier Legal Services at jfournier@jeflegal.com or 860.670.3535 now for a free consultation and planning session.