Setting up your company as a Limited Liability Company (LLC) offers the simplicity of few compliance requirements and the peace of mind that your personal assets are protected. In addition to filing your articles of organization with the state when establishing your LLC, you should also consider setting some internal ground rules for how you manage and run your LLC.
To make sure all members of your LLC (including yourself!) understand their roles and responsibilities, I recommend creating an operating agreement. Although most states don’t require you to have one, you should consider it. It provides evidence that your personal and business affairs are separate. And an operating agreement can go a long way toward helping you avoid misunderstandings, arguments, and all-out brawls between business partners.
Most LLC operating agreements are short and sweet, and they typically address the following five points:
1. Percent of Ownership/How You’ll Distribute Profits
Many LLCs choose to assign members’ percent of ownership according to the percentage of the total funds they invested into the business. This isn’t always the case, however. For example: Although one member may have invested 80 percent of the funds, the one who invested 20 percent might be doing more work in running the business. Therefore, it might seem fairer for members to have more equal ownership percentages. Your operating agreement should specify the percent of ownership to make it completely clear.
The same goes for distribution of profits. LLCs offer flexibility in how you can split your business profits. While often the percent of profits individual members get is directly related to ownership percentage, you might decide a different arrangement would be appropriate. Your operating agreement should spell that out, so there’s no confusion.
2. Your LLC’s Management Structure/Members’ Roles And Responsibilities
When you form your LLC, you can choose to set it up as either member-managed or manager-managed. When member-managed, the owners run the company day in and day out, actively making decisions and conducting business. If you opt to have your LLC manager-managed, you elect a manager to run the business. It’s important to specify the roles and responsibilities of your LLC’s members (and manager, if applicable), so everyone knows what they should be doing and the authority they have.
3. How You’ll Make Decisions
For decisions that require a vote by members, your operating agreement should identify if they need a majority or unanimous outcome. In many states, the default is for voting power in LLCs to be proportional to ownership percentage. If this suits your business, great! But if it doesn’t, you can modify it so it makes sense for your situation. You could even give all decision-making authority to one person if you like. Or you might state that one person has responsibility for day-to-day operational decisions, but major decisions (such as entering major contracts with vendors or buying another business) require the agreement of members.
4. What Happens If A Member Wants Out
In the event any members decide to exit the business, you need to address what will happen to their ownership interests. Having this laid out in your LLC operating agreement will ensure you’re not scrambling to figure it when someone leaves for personal reasons (or—heaven forbid—dies).
For example, you might stipulate that if a member chooses to leave voluntarily, she must offer her ownership interest to the other members before seeking anyone else to buy it. If a member passes away, you can document that the transfer of her ownership to a third party needs approval by the other members. I recommend your operating agreement also describe what should happen if a member files for bankruptcy or gets a divorce.
5. What Happens If You Want To Close Your Business
You won’t have dissolving your LLC top of mind when launching your business, but it’s wise to think about the unthinkable just in case it does become an unwelcome reality. Considerations to address in our operating agreement include the steps that should be taken when dissolving the LLC and how your LLC’s assets should be divided after its debts are paid.
I encourage business owners to treat their operating agreements as living documents. As things change in how you want to run your company, you should update your LLC operating agreement to reflect modifications in the roles of members, changes in how you’ll want profits distributed, a new business address, etc. By making sure your operating agreement reflects your current situation, you’ll be better prepared to handle any questions or misunderstandings that arise regarding how your company should be run.
Fortunately, most LLC operating agreements need only be a few pages long to cover all the necessary bases. You can find numerous samples on the Internet to get an idea of how you might structure yours. As with any legal document, I recommend you consider asking an attorney to review your operating agreement to make sure it has all the elements and detail you need to avoid issues down the line.
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Funded, in part, through a Cooperative Agreement with the U.S. Small Business Administration. All opinions, and/or recommendations expressed herein are those of the author(s) and do not necessarily reflect the views of the SBA.