Protect Yourself–The LLC Operating Agreement

All too often, the formalities associated with starting a business the right way are viewed as an aggravation, an obstacle in the way of generating revenue. Everybody vows to pitch in and share management duties. Everybody agrees generally just to run the ship together. Capital contributions are poorly documented if they are documented at all, and attorneys are the last thing that anybody wants to spend money on. It’s much easier to pull free forms off of the internet and have everyone sign them … even if no one really understands what they say.

Many small businesses these days choose to organize themselves as a limited liability company. LLCs are simple to set up and run. They protect their members from personal liability for the business’s debts (so long as the members don’t assume the debts themselves by, for example, a personal guaranty) while avoiding the dreaded double taxation of “C Corporations.” But that’s only the beginning of the conversation. What, exactly, is the deal between the partners/members? How will profits be divided and distributed? Who will manage 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? 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 questions go on and on.

And in the case of an LLC, these questions should be answered by the governing agreement of the entity, which is called the “operating agreement.” 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. 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 larger investment in the same attorney down the road when things go wrong and nobody seems to know the deal.

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