One of the first decisions made when starting a new business is the business structure. A limited liability company (LLC) offers some of the benefits of corporations and partnerships, such as liability protection and tax benefits. While some LLCs can be single-member (a single owner), most are owned and operated by multiple people.
With multiple people involved, having a clear understanding of who has decision-making authority, how profits will be shared, and other details can be critical to ensuring the prosperity of the company and the relationships of all those involved. An LLC operating agreement puts all those details in writing and avoids confusion and doubt.
What are the key elements you should cover in this operating agreement? Are there any points that you should take extra care to ensure are included?
What Is an LLC Operating Agreement?
An LLC operating agreement is a legally binding contract that outlines how the LLC is structured and operates. This is a key document for many LLCs. These agreements help to govern LLC’s internal operations and address issues that might arise. This document also protects the LLC’s limited liability status, clarifies any verbal agreements made between the parties involved, and protects the agreement in the state’s eyes.
Does Arizona Require an Operating Agreement for an LLC?
The state of Arizona does not require limited liability companies to have LLC operating agreements. However, the?Arizona Limited Liability Company Act
?does encourage the creation of one.
As most LLCs are owned and operated by two or more people, an LLC operating agreement is a good idea. By creating a written agreement that defines the details everyone has agreed to, it ensures that everyone has the same understanding, even after time has passed or new members join. With the important points clearly stated, members can reduce the number of disagreements and eliminate confusion.
What Are the Key Elements of LLC Operating Agreements?
When creating an LLC operating agreement, there are some key points that should be considered. Some may not apply to every LLC, which is why those forming an LLC and writing an agreement may wish to consult with a business attorney at Harrison Law, PLLC to discuss which ones they may need. Key Elements of many LLC operating agreements include:
- Name and Purpose:?The LLC’s name and the purpose for which it was created.
- LLC Management:?This explains if the LLC will be managed by a manager or one or more members. This section also spells out the rights and responsibilities of each member, such as voting rights, capital contributions, and managerial framework.?Transfer restrictions
?may also be included here.
- LLC Duration:?Many LLCs are formed for an indefinite period, but this section allows for the specification of a definite period during which it will operate or a specific closure date.
- Capital Contributions:?This is where all the investment contributions from the members are documented. The accuracy of this section is very important, particularly in multi-member LLCs, as it is vital tax-related information and provides a clear picture of the financial framework of the LLC.
- Indemnification:?This should explain when and under what conditions the LLC will protect members against lawsuits arising from the member’s duties for the LLC. This typically indicates that the LLC will pay legal costs or damages.
- LLC Tax Status:?Arizona LLCs have four tax designation options to choose from. These are sole proprietorships, partnerships, C corporations, and S corporations. The number of LLC members and the tax status chosen by the IRS will influence what is included here. This helps to protect the LLC’s financials and manage tax-related situations that may arise.
- Profit and Loss Distributions:?In a single-member LLC, this seems obvious. But in a multi-member LLC,?SCORE
?recommends detailing the exact ownership percentage each member has and the percentage of profits each receives, particularly if the profit percentage is not tied to ownership percentage.
- LLC Amendments:?While the agreements made today make sense, it is always possible that an LLC will need to change something in it in the future. Including information that outlines the process for modifying the LLC operating agreement will make things easier when that modification becomes necessary. Members may want to consider including voting percentages and other requirements that must be met to modify the agreement.
- Corporate Formalities Waiver:?Because LLCs are not really corporations, they usually do not follow the same formalities that corporations do. However, ignoring corporate formalities could result in significant problems for the LLC in some instances. Including a waiver of all formalities in the operating agreement can help to avoid those problems.
- Dissolution:?This section should cover how to close down the LLC in the event that all members choose to shut it down before the closure date or if the LLC was created with an indefinite duration. Additionally, it should also outline what happens when one member leaves unexpectedly, including if they die.
- Effective Date:?This is the start date of the agreement.
Do I Still Need an Operating Agreement If I Am the Only LLC Member?
A single-member LLC is a sole proprietorship. With just one owner and member, it may seem as though an LLC operating agreement is unnecessary. However, even a single-member LLC should strongly consider having an operating agreement. This agreement would cover details unique to single-member LLCs, such as:
- Separation of the Business From the Individual:?Ensure the courts respect the liability protection afforded by an LLC by taking clear, conscientious steps to organize the business as a separate entity from the individual with an operating agreement.
- Clarify Succession:?Without a written agreement, if the owner dies or becomes disabled and unable to run the business, the LLC may be forced to dissolve. With an operating agreement, the owner can specify what they want to happen or who they want to take over in the event of their death or disability, ensuring the business continues operations even in their absence.
- Provides Discretion for Compensation:?If the owner is considering rewarding employees for hard work with ownership in the company, a written operating agreement gives them discretion in determining the specific details of that compensation.
- Define Non-Member Investors Roles:?Some single-member LLCs have investors who are not members of the LLC. In these cases, a written operating agreement details what each non-member investor’s role will be, who holds decision-making authority, and how profits and losses will be distributed or other information regarding repayment of the investment.
The formation of a new LLC can be an exciting time. With visions of a thriving business at the forefront of everyone’s mind, you may not want to consider that there may be a day when everyone is not in agreement on how things should be handled. Alternatively, you may want to bring in new members, leave the LLC, or dissolve it. A written LLC operating agreement can ensure that there are policies and procedures in place and that everyone is held to the same standards.
