The Importance of the LLC Operating Agreement

All too often, business partners view the formalities associated with starting a business as an unnecessary obstacle. Why document our deal when everyone knows who is going to do what and how the profits will be split? Capital contributions are poorly documented if documented at all, and lawyers are the last thing that anybody wants to spend money on. It’s much easier to pull free forms off of the internet and have everyone sign them, even if no one understands what they actually say.

Free forms do not replace careful planning. Many small businesses organize themselves as a limited liability company these days, and effective organization depends on the business owners' thinking through a number of issues:

  • What, exactly, is the deal between the partners/members?
  • How will profits be divided and distributed?
  • Who will manage the LLC?
  • Who will have what vote in the management of its affairs?
  • How do members get in and out?
  • What happens if a member wants to sell his stake?
  • Are the members going to be free to compete with the LLC?
  • What will happen if the LLC wants to go into a new lines of business?
  • How will the LLC be capitalized and how will its profits be distributed?
  • When the LLC is dissolved, what order will the assets be distributed in?
  • What are the tax consequences of the way the LLC is set up?  

With an LLC, these questions should be answered in and by a binding, governing document known as the Operating Agreement.

If you are going into business with others as an LLC, then you must insist on a written operating agreement that anticipates and answers the questions listed above. You should have your own lawyer. An attorney who represents the LLC cannot show favoritism to one member over another; he cannot promote and protect your interests where they are contrary to your partners'. That's precisely why, when negotiating the deal, you need your own attorney.