What to Include in the Operating Agreement for your LLC
Forming a limited liability company (LLC) can be a good idea for a real estate investor. Conducting business dealings through the LLC limits your potential exposure should legal difficulties arise. An essential tool, your LLC should also have an operating agreement in place to clearly define the key responsibilities and compensation strategies for everyone concerned.
A good operating agreement establishes percentages of ownership, shares of profits and/or losses, rights and responsibilities and what will happen to the company if a partner should decide to leave. While many states do not make an operating agreement a formal requirement, it’s a prudent thing to do nonetheless. Furthermore, even if you’re the sole owner, having an operating agreement in place formalizes your LLC before the courts, lending credibility to its existence.
According to our friends at NOLO Press, a strong partnership agreement covers:
Percentage Interests in the LLC
Presumably all of the partners made some sort of financial commitment to get the business started. This portion of the operating agreement sets forth what each entity can expect to receive in exchange for their investment.
Rights and Responsibilities
Having a clear understanding of who is responsible for what activities of the business and what their rights are in terms of running the business can streamline practices, minimize confusion, and give you a frame of reference should you need to settle a disagreement.
In many cases, voting power is based upon the level of investment each partner has within the organization. However, some partnerships are more egalitarian and ascribe to per capita (one-person-one-vote) rules. It’s really up to the partners to decide.
Allocation of Profits and Losses
Agreeing up front on how much financial liability each partner accepts is crucial to maintaining a healthy working relationship. In most cases, percentages are allocated based upon the amount of investment, but this isn’t absolute.
Who’s going to be the lead partner? Who will handle finances? Who will handle day-to-day decisions? Who hires and fires? Etc, etc, etc…
Rules for Holding Meetings and Taking Votes
How often are meetings to be held? Where are they to be held? How are meetings governed? What sorts of decisions require votes? What are the procedures by which voting is conducted?
Buyout, or Buy/Sell Provisions
If a partner dies, does their share accrue to the other partners, or can they will it to their heirs or assigns? If a partner wants to leave the business, what is the procedure by which they cash out? In the event of a debilitating illness or injury, to whom will responsibilities accrue and by what process?
A well-drafted operating agreement helps you guard your limited liability status, head off financial and management misunderstandings and make sure your business is governed by your own rules – as opposed to default rules created by your state, or decisions rendered by a judge. For these reasons, even though the law doesn’t always require them, operating agreements are an essential aspect of the articles of organization for your LLC.
You really don’t want to go into business without them.
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