Outline your ideas and wishes prior to meeting with your attorney
An LLC (limited liability company) operating agreement allows you to structure your financial and working relationships with your co-owners in a way that suits your business needs and, often, your family needs.
An operating agreement will help to protect your limited liability status, decrease the likelihood of misunderstandings regarding the financial, business and human resource management of your company. It will also provide you and your partners or family members with a foundation for discussion when issues arise. Finally, it is a very important legal document that is required in some states and key to sound business management practices. Remember, in electing to be an LLC, you are taking steps to ensure that the courts will respect your limited personal liability. An operating agreement is an important part of formalizing that structure and adding to your personal protection.
In addition, every state has laws that are the ‘default’ operating rules for an LLC. These default rules may or may not represent your operation or your wishes. Developing your own operating agreement means that in many cases, your agreement will govern your final outcome.
Many small businesses choose to develop an operating agreement (OA) that describes many aspects of their working relationships. You can craft your agreement to contain any pertinent information that is important to you and the operation of your business. However there are some key elements that should always be in an OA:
- Members’ percentage interests in the LLC
- Members’ rights and responsibilities
- Members’ voting powers
- Mow profits and losses will be allocated
- How the LLC will be managed
- Protocols for holding meetings and taking votes
- Buy-sell rules – which determine what happens when a member wants to sell his or her interest, dies, or becomes disabled.
It is imperative that a qualified and experienced attorney crafts the final version of your operating agreement. Remember, these are legal documents and they are designed to protect you in case of a dispute, death, disability or other serious liability.
However, some business owners and family members find it useful to begin by crafting a ‘Plain Language Agreement’ – a document that outlines your ideas and wishes prior to meeting with your attorney. This will give your attorney some indications of the things that are important to you and your partners or family members.
This is a list of items you might wish to discuss with your fellow business owners – taking note of your ideas, wishes, questions and concerns:
- What is the formation of the company (ownership and structure)
- Compensation – how will everyone get paid?
- Community property – who owns the equipment, the name, the debt, etc. For example – do non-active spouses share in the ownership and responsibility? Does a laptop that belongs to a working owner also belong to her husband who does not work in the company?
- Performance – how will you deal with non-performing family members or other employees?
- Decision making – how will decisions be made in the company – by the Board? The family? Managers? Who can vote – who has a voice at the table?
- Financial reporting – how often will this be done – what does it include – who gets access to the information?
- Management – who will manage the company – how will roles and responsibilities be allocated? What about titles?
- Meetings – how often, for what purpose, who will call them, will minutes be taken? Which meetings are confidential and which are not? When do you include parents who no longer work day to day in the business in the meeting process – or not?
- Limitations and liabilities – how much money can members spend without a vote or consent of the other members? Can a family member/owner take out a loan against the company? What happens if a family member goes bankrupt? What happens if a family member tries to defame the family name or the business reputation? Can a family member open up a competing business?
- Hiring – who can hire? What are the requirements? Do family members need to meet any certain requirements? What about the use of contractors? Who is responsible for making sure that the hiring practices are within the law?
- Maintaining books and records – is this done on-site, internally or externally? Who is responsible for protecting the assets? Who is responsible for intellectual property? Who is responsible for the back-up of records?
- Annual accounting – what is the reporting structure – who gets financial info? Do we use a cash or an accrual method? When do we file our taxes? What tax structure should we assume? What assurances do we give about providing K1’s?
- Bank accounts – who has access? Who can move money? What are the checks and balances?
- Termination, expulsion or dissolution – what to do if you have a bad apple, or you have to close the company. Who can make these decisions? Where will the family go to for help? Who are their trusted advisors? What constitutes a breach that warrants an expulsion from the company for an owner?
- Outside activities – what can owners do outside of the business. Can they operate another business? Can it be similar to the family business? What are the boundaries or concerns? If they do open another business – can they take clients from the family business?
- Dispute resolution – does the family want to state what would happen if there was ever a major dispute? They might consider mediation and then arbitration as an alternative to litigation.
- Insurance and deferred compensation – what type of insurance do they plan to carry on key individuals and who owns the policies? What type of deferred compensation are they setting up for current owners/managers who may want to exit from the company someday? What type of pension or benefits are they willing to pay to retiring/exiting members?
- What do you want to do if someone wants to leave – withdraw from the business? What happens to the ownership? This is important in crafting the Buy/Sell agreement. So, do the remaining owners want first right of refusal? Can you sell to non-family members, etc.
Remember, these questions are for your use – to stimulate questions, ideas and possibilities. They, in no way represent legal advice or direction. Please take some time to consider the questions above, craft your ideas and share these with your attorney.
For an example of a plain language operating agreement, see below.