Operating Agreements

source by: trustmakers.com

Distributive Shares

In addition to receiving ownership interests in exchange for contributions of capital, LLC owners also receive shares of the company's profits and losses, known as "distributive shares." Often, an operating agreement provides that each owner's distributive share corresponds to his percentage of ownership in the LLC. For instance, because one member owns only 35% of his LLC, he receives just 35% of its profits and losses. On the other hand, another member is entitled to 65% of the LLC's profits and losses since he owns 65% of the business. (If an LLC wants to assign distributive shares that disproportionate to the owners' percentage interests in the LLC, then rules for "special allocations" will have to be followed.)

Distributions of Profits and Losses

In addition to defining each owner's distributive share, an operating agreement should answer these questions:

How much of the allocated profits of the LLC (the members' distributive shares) must be distributed to the members each year?
Can members expect their LLC to pay them at least enough to cover the income taxes they'll owe on each year's allocation of company profits? (An LLC owner, like a partner in a partnership, has to pay income taxes on profits that are "allocated" to him, not just on profits that are paid out. When profits are put back into the business instead of being paid out, they are still treated as income to the owners, in the proportions allocated.)

Will distributions of profits be made regularly or are the owners entitled to draw at will from the profits of the business? Because the owner and co-owners may have different financial needs and marginal tax brackets, allocation of profits and losses is an area to which particular attention should be paid.

Because the owner and co-owners may have different financial needs and marginal tax brackets, allocation of profits and losses is an area to which particular attention should be paid.

Voting Rights

While most LLC management decisions are made informally, sometimes a decision is so important or so controversial that a formal vote is necessary. There are two ways to split voting power among the LLC members: Either each member's voting power corresponds to his percentage of interest in the business, or each member gets one vote, called "per capita" voting. Most LLCs pass out votes in proportion to the members' ownership interests. Whichever method is chosen, it's best to make sure the operating agreement specifies how much voting power each member has, as well as whether a majority of the votes or a unanimous decision will be required to resolve an issue.

Ownership Transitions

Many new business owners fail to think about what will happen if one owner retires, dies, or decides to sell his interest in the company. These concerns may not be thought of now, but such situations come up frequently for small business owners, and it is best to be prepared. Operating agreements should include a buyout scheme, i.e., rules for what will happen when one member leaves the LLC for any reason.

How to Create an Operating Agreement

Obviously, the owner will need assistance to make his own operating agreement. There are many sources for blank or sample LLC operating agreements, but the owner must be sure that his operating agreement is drafted to suit the needs of both his business and the laws of his state.

Business Services

• Business Licenses & Permits
• Bylaws & Operating Agreements
• Registering a Business Name
• Employer Identification Number
• Do Business in Additional Countries

Business Structures

• Limited Liability Company
• C Corporation
• S Corporation
• Nonprofit Corporation
• Professional Corporation
• Limited Partnership

Small Business

• Business Term Glossary
• Customer Reviews
• Frequently Asked Questions
• Get a Quote
• Our References
• Small Business Podcasts