The Benefits of an Operating Agreement for LLC Members
Jan. 7, 2022
A Limited Liability Company (LLC) is a cross between a partnership and a corporation that helps protect the founding members from liability in lawsuits and other adverse actions. They are only liable for the money they have invested in the business.
LLCs are a relatively recent business structure phenomenon. Wyoming was the first state to enact a formal LLC statute in 1977. Now, all 50 states have statutes regulating the formation of a Limited Liability Company.
In Michigan, you can form an LLC using a simple four-part form called Articles of Organization. The only required fields are the name of the LLC, the purpose of the LLC (but can be left blank for all legal purposes), the duration of the LLC (if not perpetual), and the name and address of the registered agent. Then obtain an EIN from the IRS.
However, if you form an LLC without an accompanying operating agreement among the members (the founders or owners are known as members), you could open yourself up to endless disputes and a mismanaged operation.
If you’re thinking of forming a business as an LLC in or around Troy, Michigan, or throughout Oakland and Macomb counties, contact me at Redmond Law Group. I have more than 19 years of experience representing clients in business law and can help you draft a solid operating agreement to keep your LLC operating smoothly and its members’ roles and responsibilities clearly defined.
Benefits of an LLC
The most obvious benefit of an LLC, which sets it apart from a sole proprietorship or even a partnership, is that personal liability is limited to the assets you transfer to the LLC to begin or continue operations. In other words, your home, possessions, and personal bank accounts are protected from legal actions arising from the operation of the LLC.
Another benefit is taxation. Profits and losses align to the members according to the formula set forth in the operating agreement. An LLC is not recognized as a business entity, so taxes can be filed as a sole proprietorship, a partnership, or a corporation.
Unlike a corporation, an LLC also does not need a board of directors, an annual meeting, or complex recordkeeping. You can also choose your own management structure. The members can split management duties among themselves or opt to hire management from outside.
Why an Operating Agreement?
Remember, forming an LLC in Michigan is a relatively easy step. Just submit your four-part Articles of Organization to the state. To do so, the only other requirement is that you have what is known as a registered agent, a person or entity domiciled in the state who will receive communications for your LLC.
An operating agreement is legally optional but absolutely vital if you want to proceed smoothly and avoid members bickering and disagreeing. Some of the important topics an operating agreement should cover include:
Division of Interest in the LLC: In other words, how is ownership divided? Does each member get an equal percentage, or is it based on monetary and/or other contributions?
Management: Will the members assume management of the LLC equally, or will they hire management from outside? If they seek outside management, what are the rights and responsibilities of the manager(s) put in place?
Rights of the Members: When it comes to decision-making time, do all members have an equal right, as in a democratic vote, or is there a voting rights class structure? If so, how are the rights of minority or non-voting members protected?
Profits and Losses: Do all members share equally in the profits and losses of the LLC, or is it determined by their share of contributions at the outset? Does one member have an outsized right to profits? Again, are there classes of participation and allocation?
Buybacks and Transfers: If a member wants to leave the LLC, how will that be handled? Will the other members buy him or her out according to a set formula? What if a member wants to transfer or sell his or her interest in the LLC? Is that permitted, or do the other members have the right of first refusal and can buy it themselves? What if one member suddenly dies? (In this case, life insurance covering the members is often the answer.)
Adding New Members: If the LLC decides to add new members to raise more working capital, does this dilute the existing members’ interest? The operating agreement can include anti-dilution provisions to protect existing members.
Dissolution: Unless the operating agreement addresses the issue of dissolving the LLC, the sudden departure of one member can force the dissolution of the LLC, as by law its continuance depends on the tenure of its members. There should be buy-sell agreements in the operating document to cover this possibility.
These are just a handful of important considerations to be addressed in an operating agreement, but they – and others not mentioned – are vital for the smooth operation and survival of the entity.
The beauty of an LLC is that you have a lot of freedom in how you structure it, but you must consider the consequences – intended or unintended – of every clause in the operating agreement.
How Redmond Law Group Can Help
Crafting an operating agreement is a necessity when forming and protecting a Limited Liability Company. Without it, the business could disintegrate into competing voices and interests.
Choosing how to address each issue facing the LLC as an ongoing business entity can be complex and tricky. You definitely need the guidance of an experienced business law attorney.
If you’re thinking of registering an LLC, or you already have and you need an operating agreement, contact me at Redmond Law Group. I proudly serve clients in Troy, Michigan, and through Macomb and Oakland counties.