How to Create an LLC Operating Agreement

When creating a new LLC for a bootstrapped new small startup, it may be OK to use an online service to do the routine filings just to create the entity. Although I have no affiliation with them, I recommend www.mycorporation.com.

However, if you expect more than one owner or investor, now, or in the near future, if your business is in a highly regulated industry, or if there is anything else unusual or high risk about your business, you should hire an attorney to help draft the "Operating Agreement", which is the agreement among and between all the owners (called “Members” in an LLC).?

The one page Operating Agreement you will get from any online service may suffice temporarily, for a new, solo owner, basic LLC, but will most likely not address many things you should cover for these other use cases.?

For example:?

1. ?Roles and Responsibilities?

a. ?Who has what responsibilities, titles and obligations?

b. ?Who has what authority (e.g., to make certain decisions, or spend certain amounts, without calling a vote)?

2. ?What happens if the owners disagree? Which issues require simple majority vote vs supermajority vs unanimous vote??

a. ?Some issues might be more mundane (e.g., pricing, choosing suppliers, etc.)?

b. ?Others much more material (e.g., whether or not to pivot, or add a new line of business),?

c. ?Others even more so (should we try to sell the company or close the business?)

3. ?Transitions.

a. ?What if a Member dies,?

b. ?What if a Member is incapacitated,?

c. ?What if a Member wants to exit this business and/or sell its ownership interest??

d. ?You may want to consider a right of first refusal for the LLC and/or the other remaining members to buy out any ownership if and when a Member wants to exit (or has to, e.g., due to death, disability, retirement, etc.).

4. ?How are profits (and losses) distributed vs reinvested? ?

a. ?What if some Members are also employees or getting a salary and others are not??

b. ?What if Members are required to pay “phantom tax” on profits, then you’ll want mandatory tax distributions.

c. ?For dissolutions, or sale, do you take into account not only percentage ownership but also cash contributions too?

5. ?Fiduciary duties and restrictive covenants. Members generally owe no fiduciary duties to the LLC or their fellow members unless you say so.?

6. ??Protect member rights. Protect against “minority squeeze out” techniques by controlling members or managers. From rights to see LLC records to protections against dilution.

7. ?Tax elections. With more than one member, LLCs are taxed by default as partnerships, requiring the filing of a Partnership Tax Return (Form 1065). However, many LLCs elect to be taxed as an S-Corporation (Form 1120S). But if you want to be treated as a pass through S-Corp (to avoid double tax) you must say so in your Operating Agreement. ?Also consider a BBA tax election too.

8. ??Member Voting Power. In most states, if you are silent on the matter, each Member gets voting share based on their ownership (eg a 99% owner gets 99% of the voting power). However, in some states (for example, in Georgia), unless you say otherwise, each Member gets ONE equal vote, regardless of percentage ownership. For example, a 1% owner of an LLC could inadvertently have equal voting power to a 99% owner, in certain states, if an Operating Agreement fails to properly address membership voting rights.

For these reasons, among others, you will want to consult with a lawyer when creating your LLC Operating Agreement.

#LLC #OperatingAgreement

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Brian Heller is a corporate lawyer for Outside GC, a virtual law firm. As a virtual firm, with low overhead, we charge about 1/3 what a big firm does for lawyers with the same resumes.?

Contact Brian at [email protected] for a no risk, free consultation.