The Importance of an Operating Agreement in an LLC
What is the importance of an operating agreement in an LLC? If you have an LLC and you’re not the only member, member refers to owner when we’re talking about LLCs, if you have a partner or multiple partners and you all are members of an LLC, then you have to have an operating agreement, it’s not legally required, but it is highly recommended for many reasons.
Let’s get into the things that are included in many operating agreements and why you need the one. When you have multiple members in an LLC, if there is a disagreement, your only recourse is litigation or to dissolve the LLC. The Nevada statute says you will have to file litigation. The judge decides, and I can tell you based on the statute that the judge is basically going to dissolve the entity and split the profits with the members depending on what percentage ownership you have.
It can be a very costly and time consuming process to go through litigation in an LLC situation where you have members that are in disagreement. I just finished one and I think the attorney’s fees ended up being around $55,000 and we ended up settling because it just became so expensive that both sides finally agreed to settle and the settlement was essentially to dissolve the company, sell the assets, split the proceeds, in this case each member owned a 50% interest, so it was an easy split. With that being said, operating agreements are the rules of the game.
Most of the time operating agreements include things such as the authority and scope of the manager of your LLC. It tells you and the manager what kind of authority they have. Maybe they only have authority to bind the company up to a hundred dollars, for example, or maybe they have full and complete authority on behalf of the company. It also talks about right of first refusal. If one of the members decides that they want out and they want to sell their membership interest, many times in the operating agreement at the beginning when you form the entity, everyone decides that the other members have the right of first refusal, meaning that they get to buy the shares before it’s sold on the open market, so to speak. The other thing included in operating agreements that’s important is the voting rights. If you have multiple members in an LLC, conventionally it’s usually based on your percentage ownership. So if you own 20%, then your voting rights are 20%. There are different ways that this can be structured. For example, I just had a client come in and I drafted an operating agreement because he was buying into an already existing business. For our purposes, I’ll just say his buy-in was a million dollars, but he only put $250,000 down. He still had to pay the other 750,000 to the company, but he didn’t have the money. What he agreed to do was part of his annual draw was going to be put right back into the company and credited towards the amount that he owed for his purchase of his company share. I say this because when we drafted the operating agreement, there were different levels of membership. There was a Class A and Class B membership, and he was a B member. So his voting rights were not the same as the Class A members because he had not paid into the company yet.
There are many different ways to structure this in an operating agreement. And that’s why it’s very important to have an operating agreement because you have to know what the rules are and you have to know who gets what vote so that you can try to avoid court and try to avoid disputes that result in litigation. So I’m just going to leave you with my opinion, which is if you are setting up an LLC and you’re going to own it with anyone other than your spouse, then you absolutely need to make sure you have an operating agreement drafted by an attorney. Don’t just get one of those forms online that probably doesn’t even have the right state information in it. You should have one drafted by an attorney with specific clauses that you guys discuss based on your situation.
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