It should also provide for dispute resolution mechanisms such as mediation and arbitration clauses in case disagreements arise between members. ~ Linda Shaffer, Chief People Operations Officer, Checkr
From corporate governance to a well-defined decision-making process, here are 11 answers to the question, “What are some important items an LLC operating agreement should include?”
- Corporate Governance
- Non-Compete Clause
- Book Access and Audits
- Buy-Sell Agreement
- Purpose of the LLC
- Outline of the Roles and Responsibilities of Each Member
- Change in Ownership
- Member Ownership Percentage
- Dissolution of LLC
- Profit and Losses Distribution
- The Decision-Making Process
Corporate governance is important for any business, but it is especially important for LLCs. An LLC operating agreement should therefore include provisions for how the company will be governed.
This may include specifying the roles and responsibilities of LLC members, setting up a board of directors, and outlining procedures for decision-making. Including these provisions in the operating agreement can help to ensure that the LLC is well-organized and runs smoothly.
Corporate governance is an important consideration for any business, and an LLC operating agreement is the best place to address it.
Adding a non-compete clause to your LLC operating agreement hasn’t always been thought of as necessary. However, more recent legal verdicts have suggested that this may be a wise thing to include in agreements.
Courts have rules, at least in some situations, that without the use of a non-compete clause, a member of an LLC operating agreement may not be forbidden from competing directly or indirectly with the business of the LLC.
Rather than leaving it up to the courts to decide, it’s much safer to include a non-compete clause in every agreement. There’s no reason to put your business at any sort of risk that you can otherwise readily avoid.
Book Access and Audits
The operating agreement should include how and when the LLC’s books and records can be accessed and assessed, including meeting minutes and critical financial documents.
Clearly outline where the books will be held, how members can access information, the notice required for access, and with whom they can share the information, including employees, secondees, and more. It should outline outside audits, including how often and by whom LLC records will be audited.
If you are creating an LLC with more than one owner, the single most important thing to include is a buy-sell agreement. This is the provision that will apply if the owners become deadlocked or otherwise find that they can no longer work together.
Creating an agreement in advance that covers this eventuality is a must. Sadly, as a lawyer, I’ve seen way too many LLCs skip this and end up in a fight that ruins the company and leaves the owners with nothing.
When you have two owners, the most common form of a buy-sell agreement is sometimes referred to as the Russian Roulette form. In it, one party sets the price, and then the other party gets to decide whether to buy or sell at that price. This mechanism should force the party starting the process to pick a fair price rather than demanding something well beyond what the company is worth.
Purpose of the LLC
One thing an LLC operating agreement should include is a section covering its purpose.
This is because it needs to be clear what purpose the company exists for, including a statement about why its members are forming the company and whether it can undertake any other activities besides those stated in its purpose. It also sets out some goals for how members will work together to achieve this purpose.
This helps to establish the company’s boundaries and limitations and helps all members to understand what they can and cannot do with the company.
Outline of the Roles and Responsibilities of Each Member
One thing that an LLC operating agreement should include is a provision that outlines the roles and responsibilities of each member. This provision should clearly delineate how decisions will be made, how profits and losses are allocated and distributed, as well as what rights and obligations each member has in relation to the LLC.
It should also provide for dispute resolution mechanisms such as mediation and arbitration clauses in case disagreements arise between members.
Finally, the operating agreement should also include a clause that allows for amendments to be made in the future if needed. This will help ensure that the LLC remains flexible as its needs and circumstances change.
Change in Ownership
I think one thing an LLC operating agreement should include is a section that lays out the process for how to handle a change in ownership. How does an owner sell their share of the business? Who gets first dibs? Who gets second dibs? And so on. It will help clarify when there’s a change in ownership, what happens next, and how the LLC will move forward.
I also think it is important to include a section on how disputes are resolved if they can’t be resolved between the owners. It is important that everyone understands what will happen if they disagree with a decision or have some sort of dispute with another owner.
Member Ownership Percentage
It is important for an LLC operating agreement to include a member ownership percentage. There are a few reasons it is important for an LLC operating agreement to include a member ownership percentage.
First, this will help to prevent disputes between members about who owns what percentage of the LLC. If it clearly defines the ownership interests in the operating agreement, then there will be no confusion about who owns what.
Second, a member ownership percentage can help to ensure that each member receives a fair return on their investment. If each member knows what percentage of the LLC they own, then they can know what their share of the profits will be.
Finally, a member ownership percentage can help to ensure that the leaders operate the LLC in a fair manner. If each member knows what percentage they own, then they will be more likely to have a say in how the LLC is operated.
Dissolution of LLC
Dissolution is one thing an LLC operating agreement should include, and most of the time, shareholders do not give full concern about it.
The agreement must be clear about the scenario where the LLC will go under dissolution. The clauses on dissolution can be straightforward or strict. For example, some LLCs might go under dissolution if a certain percentage (75%). While some LLCs might follow very strict policies, such as court orders.
Karen Cate Agustin, Business Analyst, Investors Club
Profit and Losses Distribution
Once you’ve decided how the day-to-day tasks of running the business will be split up, you should also determine who will be responsible for the financial gains and losses that inevitably result.
How your business’s gains and losses will be divided up between the members should be spelled out in the operating agreement. Distribution of earnings and losses need not be proportional to members’ equity stakes; alternative methods are possible.
This also relies on your company’s bookkeeping systems being transparent and effective. In order to better manage the flow of money coming into and going out of your business, create separate checking and savings accounts.
The Decision-Making Process
An LLC is usually a compact, concise document. Nevertheless, it must comprehensively cover the most important aspects of organizational operation, including how decisions are made.
For example, in most states, the default position is for voting power in LLCs to be directly proportional to the ownership percentage. It’s essential to make an informed decision about whether this is suitable for your specific business, or whether it needs to be adjusted.
For instance, you may wish to nominate a selected person to have full decision-making authority, and you must detail this in the document. Or, perhaps you would like to appoint an individual to be responsible only for certain choices, such as those relating to everyday business. Are there key decisions that would need a majority vote, or a unanimous outcome? These should be specified.
Using an LLC to clarify exactly how decisions must be reached can save a lot of stress in the future, ensuring everyone agrees.