LLC Operating Agreements

Small Business
Author: Claudia Raessler, Esq.
  1. Today’s Objectives – “in the weeds” about OAs
In November we continued the story of Jackie and Camille, partners in a small manufacturing company facing a cash flow crisis. One of the key points discussed in the case study – LLC Operating Agreements, the “rule of the road” signed at formation.
I typically discuss with clients that an Operating Agreement (“OA”) is a contract by law and represent the rules of the road used to establish the Company culture and lay the foundation for running the business. Sounds simple – right? Pull a form from on-line, have a quick discussion (after all we are “partners” and we should be able to agree!) and then get to work building a business and making money. Although we have yet to see how Jackie and Camille are going to solve their cash flow problem, in the meantime here is hoping their OA met some of the basic objectives when the yellow brick road gets “bumpy”.
  1. What Are the OA fundamental subject areas at formation?
  • capital contributions tied to voting rights (not all memberships are created equal);
  • business fundamentals – taxation, accounting;
  • decision making in ordinary course v. extraordinary course transactions (not all members are managers and not all created equal);
  • assumption of risks and liabilities;
  • third party relationships;
  • unwinding if and when the event arises (including divorce, death and estate planning); and
  • fiduciary duties to each everyone involved (when and how).
Some “Weeds”
Drafting Strategies[1]
LLCs and thus OAs are a creation of state law. Today, it is likely in your state that having an OA is part of the statutory framework required on formation, i.e. the parties must enter into an OA – although typically not a document that has to be filed with the State. Some considerations to review with counsel on formation:
  • Define who are the parties to the Agreement both members and managers, discuss inclusion of the llc as a party and in some instances, and understand a party may include a creditor.
  • Decide in the beginning the management structure. As we discussed a few blogs back, failure in leadership is probably the second most common reason for small business closure. Small businesses are often the “lifeblood” of the initial members, require a lifeplan to succeed and if and when the LLC fails, envision a path for “failing well”.Dalio, Principles for Success – Fail Well. So even if your state permits an oral agreement, do not start down this path. A basic written agreement will begin the discussion of who is responsible for what and when you hit the first speed bump and avoid wasting time on who decides what even if there is a pattern of collaborative decision making. OAs can always be easily amended with a simple vote of the controlling members.
  • Develop a list of the business issues you expect to confront and address them in the OA where it makes sense to do so. As noted above, well drafted OAs will talk about taxes, contributions, capital accounts, future borrowings and events if closure and dissolution were to occur. Beyond this, your business and the individuals involved are unique and this is the time to address the uniqueness. Running a manufacturing operation and supply chain is typically complex and different than operating a gift shop. If wildly successful, the visionary will have different thoughts about how to use the net profits, support growth and charitable causes.
  • Think of your LLC and the development of your OA in terms of the life cycle of your business – like your personal life. It has a beginning where resources need to be identified for start-up. After the joy of start-up you move into the operational phase (no longer just dating) and you need to create a pathway for implementation of operations and sustainability. This does not require a forty page business plan, but some basic elements. Frankly, I do not see anything wrong with making a 3-5 page business summary or at least an implementation timeline as part of an exhibit to an LLC agreement. I suspect there are a raft of other lawyers who may not agree. Finally, businesses are about navigating successful and not so successful transition phases – be it sale, family transfers or closure – there is a process to follow and understand what should and should not be included in the OA.
  • Beware of OA “default provisions”. The practice of law has changed in many ways for the better! Well drafted forms abound and new lawyers can access the forms and fairly quickly get up to speed to provide services. With that being said, most forms contain “default” language that will only be binding when the parties agree and sign at the end of the day.
  • OAs should not be thought of as “interchangeable widgets”. There are single member LLCs where the sole member is typically the manager (total control); multi-member where the members are the managers or some combination of members; llcs with structured with general and limited partners (members); and member owned llcs with non-member managers. There are more options.
  • Finally, in a setting where bankruptcy is a concern, llcs are an evolving discussion.
Next time: January – Turning to Closure and Unwinding When it is Time to Move On!
Resources of Interest
  • June, 2019 Thompson Hine, LLP published an excellent analysis in Lexology,Launching a Startup? Consider Forming a Corporation Instead of a Limited Liability Company.
  • Small Business Trends We have listed this resource before and it warrants a revisit for general information.
  • A start up resource I have not tried but looked at briefly A monthly fee yet a resource that seems well organized and worth consideration including templates.
  • For several months I have been following Medium, several of its partner publications including the Start Up space. If you want to do general reading about everything from failure, this is an excellent place to start at $5/month. If lists help, in 2015 Ali Mese wrote about free resources in every category.
[1]National Business Institute, Checklist for LLC formation