July 18, 2022
First, a few basics. An LLC is a business structure where business owners can choose their own management structure and are not held liable for the company’s debts. It has the flexibility and lack of formalities offered by a partnership or single proprietorship combined with the limited liability of a corporation. An LLC protects you from personal liability by safeguarding your personal assets, such as your home, car, and savings accounts, in the event that your LLC files for bankruptcy or is sued.
But what is an operating agreement? An operating agreement is a written contract that contains rules for how an LLC will be run and what its management structure will be like. This document helps clarify what each member/owner's role is within the company and how they will interact with one another and any managers who may be appointed to handle day-to-day operations.
In this article, we will explore topics that should be addressed in every LLC Operating Agreement. We will go over subjects such as: naming your LLC and how to find out who owns an LLC; classifying members and roles; dividing governance and management authority between members and managers; addressing financial concerns—including how debts will be paid, and how to plan for a dispute resolution.
How do you choose an LLC name? The easiest way to choose a great LLC name is to use the free tools on the website of your state's LLC filing office. These offices provide searchable databases of available names, so you can check if your preferred name is available before you apply for your LLC's formation documents. You should also make sure that the proposed name isn't too similar to another company's and that it doesn't violate any state or federal laws (for example, it can't be obscene). To aid you in this matter, there are sites wherein you can check their availability per state. For example, if you are starting a business in California, you may want to visit a California LLC database for research purposes.
You also want to be sure the name fits your state’s requirements. According to Venture Smarter, a top site that answers everyday legal and business questions, most states will require that an LLC, or Limited Liability Company, be part of the name. Additionally, your state may prohibit some words from being used in the name, often words like "bank" or "insurance."
What is a member of an LLC? A member of an LLC is the person or entity that owns one or more units in the LLC. Members are also referred to as owners, shareholders, partners, and participants.
What is a manager of an LLC? The manager of an LLC is often different from the members. The manager can be an individual or another legal entity such as a corporation. In some states, the members have to vote on whether there will be managers for their company and if so, how many managers there will be and what their roles will be. In other states, it is up to the members to appoint managers for their company if they choose.
In most states, members/owners have complete control over any decisions affecting their business entity while managers have limited power to make certain decisions on behalf of the company (for example, hiring employees). This means that the members/owners can decide how to divide up their governance and management powers when creating their LLC. However, if you want a certain manager to have full authority over all decisions in the company, check with your state's LLC filing office to make sure that your operating agreement includes the necessary language.
The LLC is a pass-through entity for tax purposes, meaning that it does not pay federal income taxes on its own. Instead, income and expenses are "passed through" the company to each member/owner. Each member/owner reports their share of profit and loss on their personal income tax return.
How should I handle debts incurred by the LLC? Once an LLC is formed, all debts incurred by the company are considered debts of each member/owner personally. This means that each owner must be vigilant about paying off any business debts—even if they were not involved in incurring them—and may be personally liable for them if they do not pay them off promptly. It's important to understand that even companies with only one owner can run into debt problems, so it's crucial to think this through carefully when deciding whether or not to form an LLC. According to Robin Waite: The Fearless Business Coach’s blog, to avoid going into debt, consider the following: hiring a financial adviser, maintaining up-to-date with your accounts, not falling behind on taxes, and preventing your accounts from running empty.
The operating agreement should provide rules for resolving disputes. The members of an LLC have the right to agree to whatever dispute resolution mechanisms they want, including arbitration, mediation, and/or litigation. They may also agree that disputes will be resolved by a majority vote of the members or by a unanimous vote of the managers.
Finally, many operating agreements contain provisions providing for binding arbitration in case of a dispute. This means that even if there is no written agreement requiring arbitration in any particular situation, parties can still agree in advance to use binding arbitration as their sole method for resolving disputes. In other words, once such an agreement is signed by both parties and becomes part of their operating agreement, it can be used anywhere in the world so long as it applies equally to both parties involved in a particular dispute and so long as both sides are bound by it!
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