Operating agreement essentials

Because every LLC should have an operating agreement, you must know what to include in the document to avoid disputes and litigation.

Start your company on the right foot by building it on a solid foundation. Consider your operating agreement an investment in your new business that will reap many dividends.

The following four essential components will help assure that you have a bulletproof operating agreement.

Your operating agreement should be in writing.

If you draft and adopt a written operating agreement, you can avoid subjecting your company to default operational and governance rules outlined in your state's legal code.

The problem is that state law assumes the LLC will have a written agreement with operating details. Consequently, state law only provides generic provisions to address situations where more specific provisions would better serve you.

Don't place the future success of your business at risk. But that's precisely what happens when you subject yourself and your business to the generic provisions of the state code.

Only when it's too late will you discover that most generic provisions won't work for your business.

Let's take a real-world example: Many state LLC laws state that members must share equally in company profits and losses, no matter how much capital and services each member contributes. But the exact opposite is usually intended.

Having a properly drafted and executed operating agreement would remedy this situation.

Every member must sign your operating agreement.

Since the operating agreement governs everything between and among the members, you must ensure that every member signs the document.

The biggest mistake you can make is going through all the effort to prepare an agreement but failing to have all members sign it.

Carefully consider how you will manage your LLC.

When it comes to a multiple-member limited liability company, a common issue is having too many managers. Too many people have too much often misplaced authority to act on behalf of and govern the company.

The best time to determine the management structure of your multiple-member LLC is at the time of formation.

In general, you have two options: member management and manager management.

Member-managed LLCs are the most common. Member-managed LLCs give members equal authority to manage and act on behalf of the company, much like partners in a partnership. In most states, member management is the default absent a contrary election in the organizational document or the operating agreement. Member management is usually most appropriate for single-member LLCs. But when the LLC admits more members, it becomes a less attractive option.

Manager-managed LLCs specifically appoint certain members or non-members to manage and act on behalf of the company, much like officers in a corporation. And when the number of members increases, a manager-management structure is often the better alternative.

Make the decision early on whether you always want every person admitted as a member to be an active, executive-level manager. If not, a manager-managed company will save you time and spare you much grief later.

Specify relative member interest, contribution, and distribution rights and responsibilities.

More often than not, people get together and agree on a business venture orally: they discuss who owns what and who will do what. They organize the LLC but fail to document, in writing, what they intended.

Time passes, and the business grows. Memories begin to fade while members start to disagree. Pandora's box opens.

Arguing about issues once agreed upon by everyone wastes time, money, and energy. Regrettably, the disputes give rise to lawsuits, and almost everyone loses. The attorneys, however, make out like bandits.

The lesson:

• Document everything in writing.

• Make sure every member signs the agreement.

• Specify, in exact detail, each member's interest, contribution, and distribution rights and responsibilities.

• Amend the agreement in writing whenever anything of substance changes amongst members.

Take the time and effort to ensure your operating agreement is drafted correctly for your situation and signed by all the parties involved. Then, on an ongoing basis, amend and update your company records as the business evolves.