Limited Liability Companies are the most popular business entity used in forming any new business. This is because of its flexibility, tax friendliness, and protection of personal assets from business liabilities. They are easily set up, and many people create them online themselves, use a service or hire an attorney to create them. Regardless of how they are created, the owners should take great care in drafting the company’s Operating Agreement.
Limited Liability Company Operating Agreement
A properly drafted operating agreement will help avoid turmoil
Every limited liability company in New Jersey has an Operating Agreement. Either the owners have drafted one, or it will be construed that they have adopted the terms of the revised Limited Liability Company statute as one. (Did you ever read a statute that you fully understood? How about one that was essentially written by law professors?) The Operating Agreement is important, in that it sets up how the company is to operate, the owner’s duties, obligations and rights. It is a legally enforceable and binding document, and, although serious, left to their own devices, new business owners often fail to draft one, or are not advised of the need for one. Still worse, many just print one off a website without fully understanding its impact.
Get the Operating Agreement Right—At the Beginning
When a new business starts, all of the partners are positive and enthusiastic. However, once the business starts, it is inevitable that politics, disagreements, and power-plays will occur. It is essential that you get the Operating Agreement right, at the very beginning of your venture, while everyone is amicable. Change will be extremely difficult later on. Each owner should review a draft Operating Agreement carefully, and ask themselves, “How will I be protected if something goes wrong?” And, I know that when you start a business, there isn’t much money to spend, but, it’s worth the money to have an attorney review the document and have him or her give you the benefit of their experience. The attorney has seen what happens when things go wrong. An attorney can suggest protective clauses that you have never considered given their experience. It shouldn’t cost much, and it will certainly be less expensive than if you just “winged it”.
Nightmares
Many new LLCs have two owners. Their Operating Agreement gives them each a fifty percent interest and equal vote. At the beginning of your business, you may say to yourself, “Well, we get along. I can’t imagine we would disagree”. But if you do, there is no way to break a tie vote: you both have an equal vote. How are disputes to be resolved?
What about profits? Many Operating Agreements say profits are to be distributed in accordance with each owner’s interest in the company. Then, all owners have an equal interest. Let’s say, each of three owners has a one-third interest. Profits would be distributed one-third to each. But, as time goes on, one owner is the only one bringing in the work. That one owner is going to get mad if profits keep getting equally spread to the others.
You can provide for this in the agreement, now, before it becomes an issue.
How about a partner who isn’t pulling their weight? How about a partner who wants to sell their ownership interest to a stranger. How about a partner who dies—who gets the ownership interest? All of these questions need to be answered at the very beginning, or it may be litigated later.
Reality Check
Once the issues have been provided for in your Operating Agreement, step back and think about the clauses. Are they what you want? Are they workable for you? Recently, one of the owners of an LLC wanted to retire. He wanted to give his interest in the company to one of the three remaining owners. However, the Operating Agreement required him to get the approval of all of the other members before making the transfer. Of course, one of the owners disagreed, because he did not want the one owner to have a greater interest in the company than him. It turns out the retiring member wanted just that to happen because he felt abused by the objecting owner. Now, instead of a transfer, the retiring member is considering litigation. It’s not that you have an Operating Agreement that is important. It’s what your Operating Agreement says that is important.
If you start an LLC, don’t skip the Operating Agreement; don’t just print one off the internet and sign it. Take your time. After all, this is your business we are talking about. An attorney experienced in business matters can help you. We are waiting to help.