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Operating Agreements
source by: trustmakers.com
How to Create an LLC Operating Agreement
Much like corporate bylaws, an operating agreement governs the workings of an LLC.
An LLC operating agreement allows the owner to structure his financial and working relationships with his co-owners in a way that suits his business. In the operating agreement, both owner and co-owners establish each owner's percentage of ownership in the LLC, his share of profits (or losses), his rights and responsibilities, and what will happen to the business if one of the owner's leaves.
Why an Operating Agreement Is Necessary
While many states do not legally require an LLC to have an operating agreement, it's foolhardy for someone to run an LLC without one. An operating agreement helps an LLC by safeguarding its limited liability status, heading off financial and management misunderstandings, and ensuring that business is governed by the owner's own rules, not the default rules of his state.
Protecting Limited Liability Status
The main reason for making an operating agreement is as simple as it is important: An operating agreement helps to ensure that the courts will respect limited personal liability. This is particularly essential in a one-person LLC where, without the formality of an agreement, the LLC will look a lot like a sole proprietorship. Just the fact that the owner has a formal written operating agreement lends credibility to his LLC's separate existence.
Defining Financial and Management Structure
Co-owned LLCs need to document their profit-sharing and decision-making procedures as well as the set of rules for handling the departure and addition of members. Without a thorough operating agreement in place, not only will the owner and co-owners be ill-equipped to settle misunderstandings over finances and management, but he will also be subjected to the default rules of the laws in his state.
Overriding State Default Rules
Every state has laws setting out basic operating rules for LLCs, some of which govern the business unless the operating agreement says otherwise. (These are known as "default rules.").
Many states also have a default rule that requires owners to divide up LLC profits and losses equally, regardless of each member's investment in the business. If an owner and his co-owners did not invest equal amounts in the LLC, it's doubtful he will want the profits allocated equally. In order to avoid this, the operating agreement must dictate how the owner and co-owners want to split profits and losses.
In this same way, many state laws regarding LLCs will not be favorable to the business. An owner should not be tempted to rely on them to structure his LLC; instead, he should decide on the best rules for his situation and put them in a written operating agreement.
What to Include in an Operating Agreement
There are a host of issues an owner must cover in an LLC operating agreement, some of which depend on the business's particular situation and needs. Most operating agreements include the following:
While these items may seem fairly straightforward, each requires important details. It's best to ensure that the particulars are filled out in the following key areas:
Percentages of Ownership
The owners of an LLC ordinarily make financial contributions of cash, property, or services to the business to start it up. In return, each member of an LLC gets a percentage of ownership in the assets of the company. Members are usually given ownership percentages in proportion to their contributions of capital, but LLCs are free to divide up ownership any way they wish. These contributions and percentage interests are an important part of an operating agreement.
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