The Importance of an LLC Operating Agreement

The limited liability company is often commended for its flexibility, allowing members the freedom to determine how they govern their business and allocate management and financial rights. But to take advantage of this flexibility, members should enter into a well-drafted operating agreement that outlines their governance structure and member rights and responsibilities. Without an operating agreement, default state laws dictate these aspects, potentially leading to unintended consequences and bad blood among co-members.

Components of the Operating Agreement

Most states require only basic information, such as the company’s name and registered agent, in the articles of organization. The operational and structural specifics of the LLC are meant to be determined by the members. An ideal approach involves members adopting a written operating agreement that addresses their unique needs and preferences. This agreement should cover key aspects, including:

● Management structure (member-managed or manager-managed)

●   Selection of the management team

●   Decision-making processes

●   Voting requirements

●   Member duties and responsibilities

●   Profit and loss distribution

●   Ownership interest sale rights

●   Requirements for adding new members

●   Member disassociation triggers

●   Exit rights and buyout provisions

●   Events triggering company dissolution

What Happens if the LLC Does Not Have an Operating Agreement?

Each state has statutes governing LLCs, often based on uniform acts or state-specific laws. Without an operating agreement, these default rules dictate how an LLC operates. While some default provisions may align with members’ intentions, it’s unlikely that every default provision will perfectly suit their needs.

Default Rules on Management

For example, consider management structure. Many states, including Illinois, default to “member-managed,” where all members must agree on decisions and have equal authority. Members seeking a manager-managed arrangement must specify this in the operating agreement.

Default Rules on Financial Rights

Default rules also dictate the allocation of financial rights, such as profit and loss sharing. Members often prefer customized distribution methods that align with their capital contributions. Default state rules may not reflect these preferences.

Other Default Rules to Consider

State statutes often include default rules on adding new members, selling ownership interests, and unanimous consent requirements. These rules may not align with the unique needs of your LLC.

Single-Member LLCs

Even single-member LLCs should have written operating agreements. Default state provisions, such as mandatory dissolution upon death of the last member, can pose challenges to single-member LLC owners who wish to pass their business on to a family member. Operating agreements, along with estate planning, can help prevent unwanted outcomes.

A comprehensive, well-drafted operating agreement is important for every LLC. It empowers members to shape governance, financial rights, and more, preventing unintended consequences from default state laws that may not fit their needs. Regular reviews and legal counsel can help ensure the agreement remains up-to-date and legally sound.

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