What Should be Part of an LLC Operating Agreement?

Creating an LLC operating agreement is important because how an LLC is governed is largely determined by the operating agreement. 

LLC stands for Limited Liability Company. It is a popular type of business structure because it provides the owners with protection from personal liability but allows pass through taxation so the owners can report company profits and losses on their personal tax returns. Because LLCs are so popular, many people create them — but sometimes the LLC operating agreements they create are not as comprehensive as they should be.

Parman & Easterday can provide assistance with the creation of an LLC operating agreement so the agreement protects your company and your investment in your business.

If you are thinking ahead to estate and business succession planning, your attorney can also help you make certain your operating agreement is structured appropriately to make transfer and continued operation of your business possible. Give us a call today at (405) 703-9987 or (913) 385-9400 to find out more.

What Should be Included in an LLC Operating Agreement?

An LLC operating agreement should include different clauses to establish rights of members and processes for operating the company. Things that should be addressed in the operating agreement include:

• Membership interests of each member. Owners of an LLC are called “members.” The operating agreement should specify each member’s interest in the business, which may be based on the members’ initial contributions. Both the member’s economic interest and the member’s management interest should be detailed in the operating agreement. The interest of each member may be expressed as a percentage interest or as membership units . The interest of each can change as new members obtain interests in the LLC, but need not (see below).
• Anti-dilution clauses. Rules can be included to prevent an existing member’s interest from being diluted if new members obtain an interest in the LLC.
• Rules for allocating profits and losses. The default rule is that profits and losses are allocated based on the interest of the member. However, the LLC operating agreement can opt out of this default rule and can allocate profits and losses differently. For example, an LLC member with a 20 percent interest in the LLC could be allocated 50 percent of profits and losses.
• Management rules: Members can manage an LLC, or separate managers can be placed in charge of managing day-to-day operations. An operating agreement should specify how managers are appointed; when and how manager meetings will take place; and the responsibilities of managers.
• Voting rules: The standard rule is that each member gets votes equal to his percentage interest. However, this can be altered if desired in the operating agreement.  It can also include voting and non-voting interests.
• Record-keeping requirements. Operating agreements should specify what records are to be kept and what the rights are of members and managers to review those records.
• Transfer restrictions: It is common for LLC operating agreements to include limitations on transferring interests or management rights. The LLC operating agreement may require that transfers be approved by all members or a specific percentage of them, or it may require that existing members have first rights to match a third party offer for another member’s interests.

These are just a few of the clauses which can be part of an LLC operating agreement. It is also important to consider how an LLC operating agreement will affect estate planning.

The American Bar Association discussed the 2002 Tax Court opinion in Hackl v. Commissioner, which resulted in significant tax liability when the IRS successfully challenged annual exclusion gifts after the owner of an LLC gifted units of the family LLC to children and grandchildren.

Provisions in the operating agreement which affected the Hackl decision included the patriarch of the family being appointed a lifetime manager with an 80 percent vote for approval, and the patriarch having sole discretion over distributions. Clauses included in the LLC should be carefully considered in light of Hackl if you are using an LLC for estate planning.

Getting Legal Help with an LLC Operating Agreement

Parman & Easterday can provide invaluable assistance with the drafting of an LLC operating agreement. To find out how an LLC operating agreement works or to learn more about estate planning, join us for a free seminar. You can also call us today at (405) 703-9987 or (913) 385-9400 or contact us online to find out more about how we can help.