Why an Operating Agreement is Critical
Some businesses think that because the state they have filed for LLC status in doesn’t require an operating agreement they can save time and money by simply eliminating it all together. Sadly, this is a foolish decision that often sees such business owners lose their businesses the status of LLC and therefore the protections it provides resulting in their personal assets being liable in a law suit.
The job of an operating agreement is to make sure that this doesn’t happen. It provides structure to your business that’s designed to ensure your decisions fall within the expected guidelines to maintain the protection your status as an LLC affords you. Without an Operating Agreement, your LLC must follow the default rules of the state where it was filed in order to maintain liability protection. However, hiring a qualified attorney like Yoel Molina who is familiar with the LLC operating rules within the state of Florida will provide you a far superior LLC structure for your specific business needs.
If you are single-owner, an operating agreement legitimizes your LLC as a separate legal entity from your personal assets and will go a long way towards giving your LLC credibility in a court of law.
Setting Up the Managerial & Financial Structure of your LLC
If your LLC is co-owned, then you’ll need your operating agreement to also stipulate the division of managerial responsibilities and financial obligations. It should cover what to do when adding new co-owners and when a co-owner leaves. The goal is to give you clear procedures and rules on what to do if there is a dispute or misunderstanding. Without stipulating these for your LLC, co-owners will be subject to the state defaults in terms of profit shares, responsibilities, and more.
Stipulating Your Own vs. Using Default State Rules
The issue with the state default regulations is that they may not be right for your LLC at all. For example, most states require that profits (or losses) be divided evenly among co-owners. But if you have an LLC where one owner is active and a few others are simply investors, or silent partners, this may not work.
Simply put – co-owners who invest different amounts of time and money into the LLC want their fair share and the only way to ensure this is to create your own operating agreement. The best thing you can do to ensure all co-owners get what they deserve and preserve your LLC protection, therefore, is to use an operating agreement.
What to Include
You’ll need to sit down with your fellow co-owners and a qualified attorney who can help you make sure you included absolutely everything your LLC needs to stipulate in order to avoid the state default rules and ensure things are divided properly. To help you prepare for this process, here are a few of the key things you’ll want to be sure to include:
- Stipulating what % of interest in the LLC each co-owner has.
- Stipulating the Rights & Responsibilities of each co-owner.
- Setting up how profits and losses will be divided among co-owners.
- Clear outlines for how to manage the LLC moving forward
- Rules for buying out members if/when they want out or become unable to continue as a co-owner. It’s easy to overlook this, but including this in an operating agreement will be a tremendous boon on down the road when unforeseen difficulties arise.
- Defining the Voting Powers of each co-owner.
Despite the rather straight-forward nature of these issues, they do require some careful thought which is why it’s best to have your attorney present if at all possible during these discussions (or at least to have minutes they can review before your agreement is final).
Define Voting Rights
Many times LLC decisions can and should be made informally as the need arises. However, not all decisions can be made by one owner along as they are controversial or impact more aspects of the business than that co-owner has decision making power for. In cases like these, a vote should happen between co-owners. In most LLCs, voting power is split among co-owners in two different ways:
- The co-owners interest in the business directly determines their voting power. For example, a co-owner with 35% interest in the business would account for 35% of the vote on any issues requiring one.
- A simple 1 vote for 1 member ruling. No matter what your controlling interest is, you get one vote because you are one member – all votes count equally.
Though most LLCs follow the first model, there are several situations where the second may be preferred. No matter how you choose to divide voting power, be sure to stipulate what kind of issues require unanimous votes, and what to do in the case where no majority can be determined.
When an LLC is created, each owner contributes to it in either time, money, property, or goods. In return for these contributions, most LLCs divide the percentage of controlling interest each co-owner receives is directly proportional. However, you are free to divide this however you wish in your operating agreement
Profit & Loss Distribution
Co-owners of LLCs receive shares of the LLCs profits and losses. Typically the amount of shares they receive is directly proportional to their ownership share as determined by their contributions to the LLC. If you need an LLC where profit and loss shares are not distributed in accordance to ownership shares, you’ll need to use special allocations – something your attorney can help you. Specifically, your operating agreement needs to answer the following questions when it comes to profits and losses:
- How many of each members allocated profits must be distributed annually?
- Will co-owners of LLCs receive enough from the LLC to cover the income taxes they will owe on its behalf? (This can happen when a percentage of profits are reinvested into the business instead of completely paid out and it’s something co-owners need to know ahead of time to avoid turmoil)
- How will profits be distributed? Will this occur regularly? Will co-owners be able to draw profits at will?
Still Have Questions?
This simply scratches the surface of what an LLC Operating Agreement should do. You need to consult with your co-owners and a qualified experienced business attorney who can draft or review your LLC Operating Agreement. This is perhaps the most critical piece of your LLC so it’s absolutely critical to get it right. Yoel Molina has made a career out of helping medium to small sized businesses in Florida get the most protection possible out of their business-critical documents like operating agreements.
If you are considering incorporating or becoming and LLC and would like some sound legal advice from someone who knows the law and the concerns of small and medium sized business owners in Florida, look no further than the Law Offices of Yoel Molina. With years of experiences helping businesses owners throughout the state achieve peace of mind by finding the right protection for their personal assets, Yoel has the understanding, insight, and legal expertise needed to do the same for you. So give our office a call, we’d be glad to discuss your legal business needs and concerns.