The limited liability company (“LLC”) has quickly become one of the most popular corporate vehicles for start-ups and other new ventures. While there are some drawbacks (such as the number and type of investors permitted, and limitations with going public), the LLC combines the tax advantages of a partnership (no corporate level tax) with the limited liability of a corporation (limited liability for the individual shareholders or, in the context of an LLC, “members”).
An LLC needs an Operating Agreement
In general, the formation process for an LLC is generally easier than that for a corporation (fewer documents required and less formality). Nonetheless, members must draft and enter into an operating agreement that serves as the contract between the members of the LLC. An operating agreement is akin to a hybrid shareholder agreement/ bylaws for a corporation. An operating agreement is crucial for situations where a fellow member of an LLC is not pulling his or her weight, or has a different vision for the business going forward and the client wants to know the process for removing that member or dissolving the LLC.
Decisions, Decisions, Decisions
A key aspect of the LLC is that its operating agreement establishes the LLC’s decision-making process, including:
- will there be a managing member, or managing members, that will control the day-to-day operations of the LLC;
- will there be two or more classes of members, with some having voting rights and others not;
- will major decisions require a vote of all of the members – and then, will a majority suffice, or will there be a supermajority or unanimous vote required for certain major decisions (such as admitting new members or issuing new membership interests); and
- what happens if there is a deadlock amongst the members – with a vote evenly split (in such circumstances, a “show-down” provision could be used to break the tie vote).
In addition, it is recommended that dispute resolution provisions and procedures for removing/ buying out problematic members be included in the operating agreement for when disagreements become more contentious.
Money, Roles and Competition
An operating agreement should also include provisions to address issues of taxation, valuation of assets/contributions by members, and the procedure for distributing profits to members. Further, the members might want to spell out each member’s role, duties, and responsibilities in connection with the LLC’s business. Last, the members may choose to memorialize certain non-compete provisions in the operating agreement. Non-compete provisions prevent members from participating in businesses that compete with the LLC during their tenures as members, and for some period after they leave.
Design Your Own Operating Agreement
Please note that this is only a brief overview of some of the issues that should be addressed or considered when drafting an operating agreement. The specific operating agreement provisions will inevitably vary depending on the intended relationship between the members, the nature of the underlying business, and the complexity of the investment options for prospective members.
It is highly recommended that you retain qualified legal counsel to ensure that any operating agreement that you use provides adequate levels of protection to safeguard your investment of time and money while anticipating potential conflicts and other contingencies.
If you are interested in learning more about this topic or require the review or preparation of an operating agreement for your business needs, please e-mail us at info@kleinmoynihan.com, or call us at (212) 246-0900.
The material contained herein is provided for informational purposes only and is not legal advice, nor is it a substitute for obtaining legal advice from an attorney. Each situation is unique, and you should not act or rely on any information contained herein without seeking the advice of an experienced attorney.
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This blog post was originally published in 2013 and updated on November 3, 2021.
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