Considerations For LLC Agreements
Businesses have life cycles: birth (formation), life (operation), and death (liquidation and winding up). Many business owners form a limited liability company (“LLC”) by filing a Certificate of Formation, but fail to complete the necessary structuring of the LLC to maximize the benefits of LLC. When utilized properly, the flexibility the LLC offers coupled with its liability shield makes it superior in some cases to other entities. However, when not properly considered, an LLC can cause disastrous consequences to its owners and the business itself.
Take the time to draft an “operating” agreement (aka the “LLC Agreement”) to protect the owners and the business. The importance of a well written operating agreement cannot be understated because it serves to guide the business through its various stages of life. The following discussion serves to illuminate the life cycle of an LLC to consider when thinking through your LLC’s operating agreement.
Birth
Consult with a lawyer experienced in drafting operating agreements. You and your lawyer create your LLC’s operating agreement specific to your business. Disaster awaits you if you pull your operating agreement from the internet. Your business is different than every other business and you must include the details specific to your business in the operating agreement. These details include the purpose of the business, identification of the members, their contributions to the LLC (and what happens if they make the promised contributions?), tax classifications and transferability. There are few limitations to who the members can be, or what kind of business the LLC will perform.
Capital can include more than just cash (e.g., property, services rendered, promissory notes, etc.). Thinking of such details at the creation of your LLC can help ensure your business comes to life smoothly and operates free of disputes and ambiguity.
Members hold the opportunity to determine whether their LLC will be taxed as a C corporation, S corporation, partnership or sole proprietor (among others). Experienced counsel can guide you through the maze of tax classifications.
Interests in an LLC are typically not freely transferable. However, consider the conditions under which new investors or members can join the LLC. Unless you are careful, you may end up in business with someone you do not even know.
Life
Certain aspects of your operating agreement exist to allow for smooth business operations. Clearly stating the details of the LLC’s management, for example, is highly advisable. Consider whether the LLC will be managed by a coalition of members or one central individual, a “manager”. Keep in mind that when managing an LLC, there is such a thing as too many cooks in the kitchen, however.
Additionally, think about designing a system for orderly profit distribution within the operating agreement. Agreeing on a system through the operating agreement can help prevent disputes. Keep in mind that disputes and deadlock can occur. Your operating agreement can and should provide avenues for resolving such disputes and preventing deadlock.
Death
Your business will end at some point, so plan for it! Consider your exit strategy at the beginning: will you sell the company’s assets? operate and dissolve without a sale? sell your interests in the LLC? A well drafted operating agreement includes planning for such events. You also need to consider the life events of members such as death, disability or bankruptcy.
Operating agreements should also provide for the winding up of the LLC’s affairs. Considering and accounting for all these events will save everyone time, money, and stress down the road when the LLC reaches the end of its life.
You and your business need to plan for its life cycle to maximize the benefits it can provide you. The business lawyers at Beresford Booth hold extensive experience drafting operating agreements, provide continuing legal counsel to operating businesses and transactional guidance for major changes. Contact us today to discuss how we can help you create an operating agreement to conform to your LLC’s particular needs.