Yes, you need an operating agreement for your LLC. Part #1
Forming an LLC, as a general rule, is pretty easy. You contact the Department of Financial Institutions, file some paperwork, and *poof*…you have an LLC. Actually, you don’t. You have what amounts to an empty shell, a house with exterior walls. Yes, you have ideas, some equipment, and maybe even funding, but the one factor, the one adverb you are missing is…how. How will your company operate? What is the internal machinery that will guide your company through its potentially infinite lifespan? Enter the Operating Agreement.
Because of the diversity in types of businesses and variety of potential markets to be accessed, operating agreements can differ drastically in content and design. Factors such as the number of potential LLC members and the degree of business sophistication of each member can impact how an agreement is assembled. In the next few posts, I will outline areas I think are essential to a good operating agreement. Bear in mind that I could drone on and on about the finer details of operating agreements, but my intention here is to give some general information to show you why an operating agreement is worth getting for LLC’s with more than one member.
Focus Area #1 - Initial Capital Contribution
A good operating agreement requires a listing of issue interests and the allocation of those interests between listed members. Period. No debate on this. If no record is made as to who-paid-what-and-when, huge problems arise.
One reason I am so adamant about capital contribution descriptions is a simple one: it simplifies the dissolution process. All the members agreed to the description, so it is clear how many shares each member owns - this accounting helps determine the internal power structure of the LLC, assuming it is member-managed versus manager managed.
The capital contribution section can also delineate issues such as interest on capital contributions, the form of capital if it is returned to a member, or specific banking measures for each member’s capital investment. However, the main point is make sure that each member’s capital investment is put into the operating agreement.
Focus Area #2 - Distribution of profits and losses
It is that simple. Actually, it isn’t. There are a number of ways to allocate profits and losses, but in doing the allocation, litigation costs are reduced and procedures solidified - time and again people want to fight over how much money they get, so why not formalize it in your operating agreement. Further, members tend to feel better when they know the nuts and bolts of how they will get paid (assuming you are turning a profit).
General Thoughts:
- It’s easy to get excited and move forward with a business before business matters are properly resolved. The honeymoon between all LLC members eventually comes to an end. Think preemptively at every turn.
- Always, always, always get things in writing; again, think preemptively.
- You will sleep better knowing that your business has procedures in place and in operation from Day 1 - reliable procedures allow a business to run more effectively.
Chris Moander is an independent attorney handling business law matters, business litigation, and collections matters throughout Wisconsin.
