LLC Operating Agreements – Important and Often Overlooked

All business ventures start with grand ambitions. The partners always begin on the same page, chomping at the bit to drive towards profit and success. The formalities associated with starting the business are an aggravation that only seem to get in the way of generating revenue. Everybody vows to pitch in and share management duties. Vague discussions are had about who is going to handle what. Everybody agrees generally just to run the ship together. Capital contributions are poorly documented. Individuals routinely take on company debt in their personal names (e.g., using personal credit cards to buy assets for the business). The only exit strategy discussed is to make money. Attorneys are the last thing that anybody wants to spend money on. It’s much easier to pull free forms off of the internet, have everyone sign them, and be done with that nonsense. Sometimes the documents that are generated never even get signed. Details, details. We’ve got a business to run here!

For most small businesses, a limited liabilty company (LLC) is the chosen form of business entity. LLC’s are overwhelmingly popular, and for good reason. They are simple to set up and run. They protect their members from personal liability for the debts of the LLC (assuming the members don’t assume the debts via, e.g., personal guarantees) while avoiding the dreaded double taxation of “C Corporations.” All well and good. But to say there are good reasons for choosing the LLC as the corporate form of a small business is only the very beginning of the critical conversation that must follow. What exactly is the deal between the partners (called “members” in the case of an LLC)? How will profits be divided and distributed? Who will have managerial control over the LLC? Who will have what vote in the management of its affairs? How do members get in and out? What happens if a member wants to sell his stake? When can members be required to add money? What can cause the LLC to dissolve and stop its business? Are the members going to be free to compete with the LLC? What will happen if the LLC wants to go into a new lines of business? How will the LLC be capitalized and how will its profits be distributed? When the LLC is dissolved, what is the order in which the assets will be distributed when it is? What are the tax consequences of the way the LLC is set up? The list goes on and on.

In the case of an LLC, these questions should be answered by the governing agreement of the entity, which is called the “operating agreement.” Georgia law does not require that an operating agreement be in writing, but it is usually a very bad idea to operate on a verbal, un-written agreement. The absence of a written document can make it impossible for the LLC to, e.g., borrow money and can create uncertainty about the members’ agreement as time passes and memories fade. Disputes happen, most often centering on managerial control of the entity and matters of money (e.g., division of profits). As the grand ambitions that accompanied the start of the venture crumble into bad debts, unfunded payrolls, and lease defaults, tempers flare and accusations fly. Only then do many memberss realize that they have not adequately protected their interests by negotiating and signing an operating agreement that fully and accurately states the deal between them and makes adequate provisions for what happens when things don’t go according to plan.

If you are going into a business venture that will be set up as an LLC, make sure that you have your own attorney – one experienced and competent in these matters – and that you insist on a written operating agreement that anticipates and answers the questions listed above. Realize that an attorney representing the LLC has an ethical duty not to show favoritism to one member over another. In other words, he cannot necessarily promote and protect your interests where they are contrary to those of your fellow members. That’s why, in negotiating the deal, you need your own attorney watching out for your interests, and yours only. Think of hiring good counsel as an investment in the success of the business no different than the purchase of quality computer equipment. Make sure you have a written operating agreement. Be certain that you know what it says before you sign it, and that it accurately reflects the deal that you intended to enter. Anticipate questions like those listed above, and answer them on the front end. Don’t leave important details hanging and don’t assume that verbal promises will be enforceable later. A small investment in a good attorney when the agreement is drafted can save you from a much much larger investment in the same attorney down the road when things go wrong and nobody seems to know the deal!

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