What is an LLC Operating Agreement?
Limited liability companies (LLC’s) have become the business organization of choice for most small business owners. This is primarily because of their flexibility and simplicity. LLC’s are separate legal entities apart from its members, like corporations, but are treated as “pass-through” entities for taxes purposes, such as sole proprietorships and partnerships, unless they have elected to be treated as taxable entities by the IRS.
The most essential element to any properly functioning LLC is the operating agreement. An LLC operating agreement will provide provisions that allow for the effective and efficient governance of the LLC and its members. LLC operating agreements act as a guide to LLC members in their duties owed to the company, along with their rights and responsibilities. While operating agreements are not required under Ohio law, drafting one can promote the efficient performance of members’ jobs and assist in resolving disputes.
Operating agreements can cover basic information, such as company information, rights and responsibilities of members, tax issues and member exit provisions. Such agreements can also dictate how company decisions are made, what happens if a member dies, how to resolve disputes between members, whether non-compete agreements should exist, and who owns the intellectual property of the business. The following is a list of several of the essential provisions for every LLC operating agreement:
Transferability of Membership Interests and Admission of New Members
The operating agreement of the LLC should describe the restrictions on the transferability of membership interests and explain the rules governing the admission of new members.
Divorce, Bankruptcy, and Death of a Member
The operating agreement must address what occurs to a person’s membership interest upon the divorce, bankruptcy or death of a member. If the operating agreement does not, a number of outcomes could occur that would be undesirable for the other members of the LLC. For example, a divorced member’s spouse, an heir of the deceased, or a creditor could become a member of the LLC.
Management and Voting Rights
It is critical that the operating agreement state how the LLC will be managed. For example, will the LLC be managed by its members or by elected members. If managers are elected, the operating agreement should clearly state which actions these managers may take on behalf of the LLC (such as the day-to-day operation of the business) and which actions require the approval of the members (such as business acquisitions or financing). The operating agreement should also clearly specify how the voting rights of members are established, such as based on capital contributions, per capita (each member gets one vote), or determined in another manner.
Covenants Not to Compete
The operating agreement should address any restrictions on a member’s right to compete with the LLC’s business or pursue business opportunities that that should be made available to the LLC first. While there are fiduciary duties that members owe to the LLC, these duties can be modified or discarded by the terms of the operating agreement. However, certain provisions of Ohio’s LLC statute cannot be modified by the operating agreement, but can be clarified. These include:
- Manager Duties – The operating agreement may describe the standards by which performance by the manager will be measured and state activities that will not violate the manager’s duties to the LLC.
- Duty of Loyalty – The operating agreement may state the activities that do not violate the duty of loyalty and can provide procedures to address possible exceptions to this duty.
- Duty of Care – The operating agreement can enumerate the standards by which the duty of care will be judged.
- Obligation of Good Faith and Fair Dealing – Similar to the duty of care, the operating agreement can prescribe the standards by which the performance of these obligations will be measured.
Do I Need An Operating Agreement for My Ohio LLC?
Forming an LLC with other people can be likened to a marriage. However, not all marriages last forever. Having an operating agreement in place from the outset can mitigate against the likelihood of a chaotic divorce. It can dictate whether certain decisions must be made by all members of the LLC or whether a managing member can make decisions.
What happens if there are multiple members to an LLC and they are deadlocked on an issue affecting the business? An operating agreement can resolve such disputes by having a procedures in place. If such procedures prove ineffective, the operating agreement can create a buyout provision (typically in conjunction with a buy-sell agreement). These procedures prevent the kind of gridlock that could force the company to sell its assets and terminate the business.
Finally, most businesses have some sort of intellectual property. If the business begins without a formal agreement as to who owns the property, disputes can arise later as to who owns the property and whether it is a personal asset or a business asset. To prevent this dispute, an operating agreement can define who owns the property and whether it is a personal or business asset.
Columbus and Delaware, Ohio Small Business Attorney
If you wish to create a LLC operating agreement to protect your small business in Columbus or Delaware, Ohio, contact Johnson Legal, LLC and speak with an experienced small business lawyer. Attorney David Johnson of Johnson Legal, LLC will discuss your small business needs. Call (614) 987-0192 or send an email to schedule a consultation.
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