OPERATING AGREEMENT TO MANAGE YOUR LLC

If you are involved in a family business, you have probably chosen a Limited Liability Company (LLC) as your company structure — registered with the state and governed by state laws. LLCs are suitable for many kinds of businesses where the business is formed by a few people who get together to produce a product or service that will support their families. The foundational document is called an operating agreement, and it has multiple purposes.

• Designate who manages the company and how decisions are made. Explicitly outline the scope of the manager’s power and specify which high-level transactions must still be approved by the members. Designate where members and managers’ meetings will be held, and the authority of the officers and/or managers. Ensure that the LLC complies with the applicable tax rules.
• Establish the relationship between the owners. It is a binding internal contract that dictates financial stake, management structure, decision-making authority, and rules for ownership transitions. It prescribes the standards by which to measure the performance of the contractual obligation of good faith and fair dealing.
• Dictate ownership percentages and profit sharing. Proportional allocation of distributions according to the value of initial capital contributions is common, but special arrangements are sometimes made to satisfy select investors or for the benefit of the business.
• Outline procedures for buying out an owner. Well-defined trigger events — such as departure, disability, death, divorce, default, or misconduct — along with valuation and transition rules, prevent business disruption, ensure fair pricing, and protect control when an owner leaves.
• Create a method for resolving disputes. Specific rules and safeguards can require negotiation, mediation, and arbitration as alternatives to costly litigation, which can ruin a business by draining assets and shifting focus away from the purposes and goals of the business.
• Prohibit transferring ownership to a third party outside the LLC. Specific transfer rules outline conditions under which a transfer may be made. Alternative types of authorization include absolute prohibition, authorization by unanimous or majority approval of members, and right of first refusal.
• Plan for unforeseen events between owners or in your business. It is difficult to foresee all possible disruptive events, but partner departures, ownership transfers, and deadlocks are common critical issues. Addressing these issues in the operating agreement can protect the business from forced partnerships, court intervention, and operational gridlock.
• Written with family values in mind. A good place to start is by drafting a dedicated preamble that outlines your family’s mission, and balance it with strict legal protections for your family’s core principles, such as fairness, transparency, and unity.
• Flexible future planning to fit the personalities of your family members. In addition to considering where the LLC is now, you should always consider the long-term goals of the LLC as well, to eliminate the need for substantially modifying the operating agreement if expansion is successful.

LLC owners are called members, and they have some of the same duties, responsibilities, and rights as shareholders, but they also play a more active role in the operation and direction of the company.

Operating agreements are only required in five states: California, Delaware, Maine, Missouri, and New York. No state requires an LLC to file its operating agreement with the state government — it is only required to be kept in the company’s own records. If an LLC does not have an operating agreement, it must be governed according to the default rules of that state.

Consulting with an experienced attorney at Corporate Securities Legal LLP will help you set rules and plan for the various arrangements between you and your business partners in a way that works for everyone. Operating agreements eliminate uncertainty and unnecessary strain within companies when multiple parties are involved.