If you are running a business and your friends, relatives or colleagues want to invest some capital toward your business to generate future profits, then it’s time to incorporate a limited liability company.
LLC is shortened for Limited Liability Company, which means in the situation of bankruptcy, the liability of the company will only base on the capital that company’s members have invested in and the personal wealth of the owner won’t be use in order to pay for any of the company’s liabilities. An LLC is considered as a separate legal entity from their owners, thus can be sued in the court of law.
The first state to ever pass the legislation that allow the formation of Limited Liability Companies (LLC) was Wyoming in 1977. In the current year, almost two-thirds of all the new companies formed in the United States are LLCs. A LLC is not certainly a corporation, it’s a legal form of company that provides the benefits of limited liability to its owners.
After forming a LLC company, you will need to have your rules and regulations in place that will manage and operate your company, and these rules must follow the standard requirements of the state. These rules and regulations are covered in the LLC’s operating agreement, which will help you to decide what step to take when faced with certain situation.
Why an Operating Agreement is Necessary for Limited Liability Companies
An LLC Operating Agreement can allow members to set rules for several business operations that will manage the day to day procedures of the business. It also allows to establish each owner’s ownership percentage in the company, the rights and responsibilities, profits and losses, the procedure to sell his stake in the company… When there are conflicts between members, this operating agreement will serve as a guide to resolve the problems.
Overriding the State’s Default Rules
Each state in the US has some standard rules for LLC that manage the business if the members of a LLC company doesn’t want to create their own rules. Since in the standard rules from the state, they require owners of LLC to divide the amount of profits equally among all owners regardless of their share of contribution. This by no mean is a fair rule for a LLC business, thus it is better to create your own operating agreement by using LLC Operating Agreement templates from our websites.
Amendments in the LLC Operating Agreement, is That Even Possible?
It is possible to include the provision of amending the operating agreement into your original LLC operating agreement. Otherwise, you will be subject to the state’s default rules for amending the operating agreement, which is unanimous consent of every member is required to be qualified to modify the operating agreement.
Sections that Every LLC Operating Agreement Must Contain
- Company Formation & Capital Contributions
- Distribution of Profit and Loss
- Buy-Sell Agreement
Company Formation and Capital Contributions
The Interest percentage of each member in the LLC is determined by the capital investment of each member into the foundation of the business. But it is also possible that a member who only contribute 10% of the total capital can get 20% ownership in the LLC, but only if all member agrees to do so. In this situation, that person usually the most active member of the group and handle more responsibilities as well as management the company more than other members.
Sharing of Profits and Losses That the Company Generates
The members will decide to withdraw the profit monthly, quarterly, semiannually or at will; but the chosen method must be mentioned in the LLC operating agreement or else it will be considered as a illegal step.
All the profits that the company has earned belong to shareholders and owners of the LLC but it is better to use those profit for investment and development rather than withdraw for personal use. A business should not remain stagnant, but to evolve and grow in the passage of time.
One important note is that these profits and losses are shared among members base on the distributive shares and not the capital percentage invested in the LLC. Members can set this share percentage in the LLC operating agreement after the consideration from all board members.
Management and Different Roles in the Company
A member of the company is usually an investor whose is lack of time and does not interest in managing the day-to-day processes of the company. This is a reason why there is a need to appoint new managers who will be responsible for managing the operation and to increase the shareholders and owners’ wealth.
A company member can become the manager too, but the powers within the role must be laid down in this section of the LLC operating agreement.
This section also includes information such as who will take responsible for decisions made in the company? what will be its procedure? How many managers be included in the board of directors? What are their responsibilities?
Compensation of Members and Managers
It is obvious that all manager who is rendering services for the company will be compensated, but as we mentioned earlier that this LLC operating agreement is like the bible of the company, thus why it is critical to mention that all the managers will be paid for their jobs.
In this section, the provisions that members of the company will be reimbursed if any expenses are incurred by them throughout the managing period. It is deemed illegal for members to withdraw company’s money for personal use, but there was no relevant rule in the operating agreement that allows them to do so. It is important to customize your operating agreement to cover all the rules that will allow the members of the company to exercise full control over their LLC.
Accounting and Bookkeeping
All transactions within the company and the revenue generated must be recorded in the books of the company. If you have a background in business accounting or management accounting, you will know that there are multiple ways to prepare an accounting statement. Whichever methods the members of the company agree to use must be mentioned in the LLC “Accounting” section of operating agreement. The chosen accounting method can be change in the future, but it is better to stay consistent with your accounting method to avoid possible mistakes.
If you decide to transfer the responsibility of managing the company to another manager in the company, it is critical to add a provision in the LLC operating agreement making it essential and compulsory for the manager to disclose the audited financial statement to its owners. This will protect the owners from any financial shenanigan and maintain their control.
Dissolution and the Winding Up of Company
Everything has a beginning has an end, the company’s life is also in that circle. It is important to decide the process of winding up and liquidating the company right the time of its inception. The “Dissolution” section in the operating agreement will lay down the procedures and rules through which the company can be liquidated, this process is done through voting from the LLC’s members.
Every member from the LLC has the right to sell his or her stake in the company for personal purpose. The section “Member Withdrawal” or “Buy-Sell Agreement” of the operating agreement will be answer questions such as: whom are they allow to sell their share to? Whom they cannot sell to? What are the processes to transfer his or her shares?