While not all States legally require LLCs to have an operating agreement, it is a good idea to have one in place, even if you are the sole member of the LLC.
For a single-member LLC, the operating agreement helps prove that you are not a sole proprietor, and thus maintains the integrity of your limited liability protection. For multiple owner LLCs, it ensures that everyone has the same understanding of how the business will run from the outset, and allows the business to operate in a way other than the state law default.
Make sure you check operating agreement requirements and related laws for your state before drawing up an operating agreement. Operating agreements depend on the type of business, but there are a few main points that every operating agreement should cover.
Normally ownership of an LLC is divided between members based on their level of investment. If you put down 60% of the capital, you own 60% of the business, if you put down 100% of the capital, you own 100% of the business. There are exceptions to this, for example when the enterprise is based on one partner’s idea, but they contributed less in terms of financial investment. How ownership is divided is something that an LLC can establish in their operating agreement.
Rights and Responsibilities of Members and Managers
Typically, all the members of an LLC are also its owners, but members may or may not be heavily involved in the day to day management of the business. The actual running of the business may be left to one or more members, who are then also managers. In some circumstances an LLC may employ a manager that is not a member.
The operating agreement outlines the roles and responsibilities of members and managers, so it is clear which decisions can be made by the manager, and which need to be pushed up to members. It should also include mechanisms for solving any disputes that may arise between members, or between members and managers.
Distribution of Profit and Loss
With an LLC, any earnings, or losses, are passed through the company directly to the owners, usually based on the percentage of the company that they own. Individual owners then report this on their personal tax return. Again, there are times when an LLCs may wish to adjust how profits are shared, for example to keep individual members within particular tax brackets. It is again the operating agreement where this is specified.
How to Change Owners
In many states, an LLC will automatically be dissolved if one of its founding members decides to leave the company. This can be undesirable if other members of the company wish to continue the business. If an LLC has multiple owners, it is important to account for what will happen if any of them should choose to leave.
The operating agreement should list how their share in the LLC will be distributed, how they will be compensated for their share, and what kind of notice needs to be given. The operating agreement should also account for how new members can be admitted.
How to Dissolve the LLC
Of course, there are other circumstances where all parties would like to dissolve the LLC and move on to other things. Again, how this will be done should be detailed in the operating agreement. It should look at how assets and debts will be divided between members, and who will be entitled to what parts of the LLC, including intellectual property. In this sense, the operating agreements acts as a sort of pre-nuptial agreement.
Start your Business on the Right Foot
Many LLCs fail to put a proper operating agreement in place when starting out, as it can seem like an unnecessary formality when embarking on a small business with friends. However, a solid operating agreement pays dividends in the long run by making sure that everyone has the same understanding of how the business will operate from the start.
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