What Does an Operating Agreement Cover?

By  //  March 2, 2022

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An LLC is one of the renowned business structures/business entities that business owners love. However, establishing a limited liability company (LLC) can be a very exciting or spine-tingling event. Although an LLC ranks somewhat low on every state-required record-keeping formality, it’s highly essential for business owners to readily ensure they have excellent LLC operating agreements when establishing limited liability companies.

You can check out this LLC operating agreement as it may help you discover that it’s the most vital document that controls precisely how the business entity operates, how it’s structured, etc. This crucial document also controls the alliance or connection among members in today’s multi-member limited liability companies.

What Is an Operating Agreement?

An operating agreement—or LLC operating agreement—refers to a document that sets the rules and structure for a limited liability company. It can also help address any issue that may develop during the day-to-day running of the business. The LLC agreement allows you to arrange who takes responsibility for what within the company, establishes your unique organizational management structure, etc.

Many states developed their default provisions explicitly designed to address most of the potential difficulties within an LLC. But the LLC agreement can easily prevail over all these inferences.

This document protects your interests when launching your new business. It doesn’t even matter if what you’re building is a single-member LLC.

Suppose your LLC comprises multiple members, and each of them has contributed different amounts when establishing the business. In that case, it makes sense to specify a profit split that effectively reflects these contributions.

But without an LLC agreement, your state rules more or less regulate your business (state here refers to the state where the business is established). This implies that you could end up being subjected to an even split of all the profit the business generates. This can cause a lot of disruption in your business, and you should avoid it at all costs.

What an Operating Agreement Covers

LLC agreements cover several essential factors. The majority of the factors that operating agreements cover typically have to do with every member’s business interest. It also involves how the limited liability company is effectively managed as well as the rights of each member in operating the business.

LLC agreements are always different or unique, meaning they can never be the same for two establishments. This is why you must choose precisely what’s suitable for your own business.

Here are some of the factors you must ensure your operating agreement covers:

Ownership Percentage

More often than not, every co-owner’s interest percentage in an LLC is primarily defined by the exact amount of money the co-owner contributed to the overall development of the business during the early stages.

You can split the ownership of an LLC in several other ways. For instance, there’s nothing wrong with giving up to 40% ownership of your limited liability company to a co-owner. This co-owner may even be an individual that contributed just 10 percent of the entire property to the LLC.

Some business owners can take such seemingly risky steps for multiple reasons. This may include incentivizing the co-owners that put in more work and time to get a much higher percentage of profits.

However, how you divide the company’s ownership interest depends significantly on your vision and mission for the LLC. It also depends on peculiar circumstances to you and your business.

Accounting

Your LLC agreement should specify your business’s method of accounting, including the financial year that your business uses. You should consider employing the services of an experienced and certified accountant who ensures all financial statements are duly prepared in compliance with a recognized accounting standard such as GAAP, etc.

In many cases, LLC agreements often include a provision that requires the LLC or its managers or members to fully disclose every audited statement of operations, an audited balance sheet, as well as cash flow to the co-owners of the LLC. This ensures every member is on the same page as they keep up with the business’s overall financial health.

Profit/Loss Sharing

All LLC co-owners share in both the losses and profits. This is usually carried out via distributive shares. You’ll be expected to specify these percentages in the LLC agreement.

You must also address how regularly the profits the company accrues will be distributed. Is it once a month or quarterly? Can an individual or co-owner withdraw their profits as they please or choose?

Since you have to distribute company profits regularly, you must also ascertain precisely how much of the company’s profits you want to distribute. Additionally, an operating agreement should specify whether or not the company will keep any profits to itself.

Note that LLC co-owners must pay tax on the limited liability company’s profits, even if it’s not distributed. You should consider if every member will have more than enough money to cover their taxes, especially if they can’t access their LLC profits.

Company/Management Roles

Ensure that your LLC agreement fully establishes a distinct managerial structure for your LLC. An excellent preliminary plan for a limited liability company’s efficient management, as well as the role your company takes, becomes the blueprint for carrying out your day-to-day business operations.

This is why you should deal with numerous questions that arise, such as the following:

 Will the LLC be run by a specific number of trusted managers or by its members?

How, exactly, will the crucial day-to-day decisions in the LLC be made?

Will the company have a board of directors? etc.

You may also need to determine the numerous procedures carried out before a decision is made in the company. By defining the roles and management structure of the LLC, you’ll avoid misunderstanding and unnecessary confusion in the future.

Voting Rules

Most day-to-day business decisions made for the progress and development of the LLC are informal. This means nothing is put into writing, and zero votes are taken.

However, you can’t make some decisions or even implement them independently. Decisions that will have a considerable impact on the LLC’s progress, development, or growth will require the formal votes of co-owners, directors, employees, etc.

Therefore, equip the limited liability company with the necessary rules and procedures that govern voting by lucidly describing them in the LLC agreement. Address precisely how much voting power every director or co-owner, etc., has and ensure its strict enforcement.

Withdrawal of Members

No business can thrive forever, and even if it did, the members wouldn’t be the same as those that first established it. For this reason, it’s highly crucial for you to make plans about what happens when a particular LLC co-owner leaves the business. You should highlight this plan and include it in the LLC agreement.

Conclusion

Creating an operating agreement is not as challenging as it seems. The availability of unique, customizable LLC templates has made the entire creation process a walk in the park.

However, to ensure you’re doing the right thing and not putting the cart before the horse, you may need to contact your lawyer for guidance. You may also need to collaborate with the co-owners of the LLC if you have to.

Afterward, figure out precisely what you want your LLC operating agreement to cover. You can create your customized operating agreement by answering several simple questions. Ensure every individual or co-owner signs off on it and that it becomes legal.