An operating agreement is the critical governing document used by a Limited Liability Company (an “LLC”). The Operating Agreement customizes the terms of a company according to the owners’ needs. The Agreement outlines how business decisions will be made in a structured manner — and provides clarity regarding its operations and management. An operating agreement acts as a binding set of rules by which each owner must adhere.
What Issues Does an Operating Agreement Cover?
An LLC is a business entity that is simple to form, limits the liability of the company’s owners, and provides the benefit of pass-through taxation. Although an operating agreement is one aspect of starting a new business that is often overlooked, it’s essential to understand that this document is mandatory in New York, and in most states. Failure to draft an Operating Agreement will mean that the organization and government of the Limited Liability Company will default to the statute, which does not provide much in the way of the flexibility and protection for which business owners have prized the Limited Liability Company.
An LLC operating agreement must cover certain topics, including the following:
- The percentage of each member’s ownership— LLC owners usually make cash, property, or service contributions to get the company started. In return for their contribution, they get a percentage of ownership in the assets of the LLC. A good Limited Liability Company Operating Agreement will detail the ownership percentage of the members, but will not detail the contributions – those will be limited to private agreements.
- Voting rights — Often, management decisions are made informally in an LLC. However, there may be times when it is necessary to hold a formal vote. Voting may be per capita with each member gets one vote, or it can correspond with the percentage of ownership.
- Rights and responsibilities of the members — The operating agreement should spell out the rights and duties of the members, including those concerning their capital contributions obligations, financial rights, and dissenters’ rights. Members may also have the right to bring a derivative suit and inspect the LLC’s records.
- The profit and loss allocation among members — The way in which income, deduction, gains and losses are allocated should be addressed in an LLC’s operating agreement. Specifically, a good Limited Liability Company Operating Agreement will detail an accounting procedure by which the shares of the LLC’s profits and losses are divided among the members.
- Management of the LLC — LLCs are member-managed by default by law in New York and each member has authority to make binding ordinary decisions. Major decisions require formal authorization by the members, either by majority vote or consent. However, if the Limited Liability Company Operating Agreement specified that the LLC should be managed by managers, they have the authority to make business decisions on its behalf.
- Buyout and buy-sell provisions — These provisions determine what will happen to an LLC member’s shares if they wish to leave the LLC, cannot continue their duties, want to sell their interests, or pass away.
In addition, an LLC operating agreement should define the terms used in the document, specify the purpose of the business, and contain a statement concerning its intent to form. The agreement should also establish the location of the business, how it will handle new members, how it chooses to be taxed, and the length of time it will be operating.
Using an Operating Agreement
After it has been written and adopted, the operating agreement can be used to direct the business and its operations. Significantly, the rules and regulations outlined in the agreement are to be followed when conducting organizational business. The agreement should also be reviewed periodically to ensure it meets the company’s needs. In the event that any of the terms or provisions need to be changed, the document can be amended by a vote of the members.
Contact an Experienced New York Business Attorney
Drafting an operating agreement can be complex — it is imperative to have the guidance of a skilled business attorney who can help ensure your agreement meets the needs of your LLC. Brinen & Associates is dedicated to helping business owners start their companies and ensure they have the necessary documents in place. Call (212) 330-8151 or send us a message to schedule a consultation.