Organizing Done Right: 7 Clauses for LLC Operating Agreements
Now that you have read my last blog More Than an Acronym: LLC vs. Corporation and have decided which incorporation method is most appropriate for your business, the next advisable step is to execute an operating agreement. An operating agreement is a document that customizes the terms of your limited liability company (LLC), and most importantly it outlines the financial and decision-making structure of the company. North Carolina does not require an operating agreement in order to form an LLC, but executing one is highly recommended for the stability and overall functionality of your business.
While there are no requirements for which terms should be included in the agreement, it is important to lay a strong foundation for your business by investing in a well-drafted operating agreement. As between the members of the LLC, a quality operating agreement will outline the expectations and management of the company, allowing everyone to focus on what is important: growing the business! This article discusses 7 clauses that should likely be included in an LLC operating agreement.
1. Members, Officers & Managers
Organizing the management structure of your LLC to suit your operational needs is crucial to running the business smoothly. The reality is that every company is different in how it delegates authority between its members and managers. North Carolina recognizes two structures of management for LLCs: (1) manager-managed; and (2) member-managed. Both management structures have unique features that dictate how decision-making authority is delegated and each should be carefully considered.
2. Classes of Interest & Voting Rights
An LLC can be organized with different classes of ownership interests, which provide flexibility for special allocations of profits and voting power. In a multi-member LLC, ownership is divided in two ways: (1) by percentage; and (2) by membership units, which are comparable to stocks owned in a corporation. Each member’s right to vote and share in the LLC’s profits is determined by the ownership class the member retains. How voting rights are allocated is important and may become outcome determinative when major decisions arise for the company.
3. Capital Contributions & Distributions
Generally, an owner can make contributions to the LLC in any form, including money or property, services, or any other direct or indirect benefit to the LLC. To the extent of each Member’s contribution, the operating agreement may set forth how economic profits and losses are allocated among the members and how distributions will be made. Depending on the management structure, the decision whether to issue distributions and the amount is set at manager’s discretion or may be required under the operating agreement. Operating agreements often provide for both required and discretionary distributions.
4. Binding Authority of Members & Managers
An Officer/Member’s authority to bind the LLC is an important issue for any business. In a member-managed LLC, each member usually has the authority to bind the company. In a manager-managed LLC, the authority to bind the company is usually vested in the manager. In North Carolina, unless otherwise stated in the operating agreement, the management of the LLC is vested in the managers, and all members by virtue of their status as members are deemed managers of the LLC. The operating agreement will ultimately control who has the power to bind the company, and how that authority is delegated amongst the members and managers.
5. Death or Disability of Members
The death of a member is an unfortunate event that is most often unexpected. For this reason, it is necessary that a well-drafted operating outline estate planning matters, and how the member’s financial interests will be liquidated. In North Carolina, when the individual owner of a single-member LLC dies, the LLC’s ownership that passes to the decedent’s heirs must pass through probate. This can be problematic and the LLC membership may be tied up in probate for months and may cause financial difficulties for the decedent’s heirs and the surviving members.
6. Transfer of Interest or Withdrawal from LLC
Except as otherwise provided in the operating agreement, an LLC member is free to transfer his or her ownership interest in the company, and the purchaser becomes a member and assumes the right to profits and liabilities to the extent of the transferred interest. To ensure the company’s stability and integrity, restrictions may be placed on each member’s ability to transfer his interests. This typically is accomplished by requiring the unanimous or majority approval vote of the LLC’s existing members.
Dissolution of an LLC is often voluntary and signifies the end of the life of a business. In North Carolina, an LLC may be dissolved automatically or by judicial dissolution. The grounds for automatic dissolution typically are outlined in the LLC’s operating agreement. When drafting an operating agreement it is important to carefully consider the events that may trigger the dissolution of the business. In addition to outlining the triggers for dissolution, instructions for the “winding up” the LLC’s business affairs should also be considered.
An LLC operating agreement is an incredibly important and complex document. As the owner, you can protect your business interests and provide for the quick resolution of partnership and management disputes by including these clauses in your LLC operating agreement. Start your business with a solid foundation by investing in a professional LLC operating agreement. Visit www.craineylaw.com or contact the Law Office of Cedric Rainey to schedule a consultation.
[This blog does not offer legal advice. If you need legal advice, contact the Law Offices of Cedric Rainey to speak with a licensed attorney.]