An operating agreement is an agreement between the members of an LLC, which sets out the rights, responsibilities, and ownership interests of each member. Most states, Colorado included, do not require an LLC to have an operating agreement and in the absence of a written operating agreement the laws of the state of incorporation will prevail. Because these state written general provisions often do not address many of the complicated situations that routinely face the multi-member LLC, one unnecessarily increases risk by creating a multi-member LLC without a specifically drafted operating agreement in place.
The primary reason most people choose to form an LLC is for the liability protection provided by the corporate form. That is, most people believe that an LLC member is not personally liable for the debts of the LLC. However, few appreciate that the liability protection remains in place only so long as the LLC remains an entity separate from the individual members. A primary function of the operating agreement is that it provides the framework by which the LLC should be run, what is allowed and not allowed, when and how to hold valid meetings, and powers of the members, to name a few. Accordingly, following the framework as outlined in a well drafted operating agreement provides the best protection against an action to ?pierce the corporate veil? and strip the members of the personal liability protection.
So what should an operating agreement cover? Some basics include: 1) identification of the members, their ownership interests and roles; 2) identification of who bears responsibility for running the entity; member- managed or manager- managed; 3) details concerning Membership Meetings and voting rights; 4) terms covering distributions of profits and losses; and 5) terms related to how or under what circumstances transfer of member interests may occur. These are just a few of the important topics that should be addressed in the operating agreement.
In sum, there are a number of relatively standard terms that should be covered in every operating agreement and several terms and conditions that should be considered and potentially drafted that specifically fit the needs of the particular business and/or members. For example, LLCs used for estate planning and LLCs used for real estate investing should have in place operating agreements that address aspects relevant to running those businesses that are inherently unique. This is why using someone else?s operating agreement is not a good idea. It is akin to borrowing someone?s tailored suit or gown, it could probably work for the night or moment, but it just won?t fit well and parts of it will be uncomfortable. Spend the time and money up front to have an operating agreement drafted for your LLC by an experienced attorney who will tailor the agreement to fit your individual business needs. The money you will spend in repairs to a poorly fitting agreement will be far more costly.
SMART TIP: Before forming a legal entity through which you conduct business, carefully evaluate the pros and cons associated with the suite of entity forms that are available. A quick call to your counsel and CPA will go a long way toward helping to ensure that the entity you select is a good fit for your objectives.
The attorneys at The AR Group, LLP provide counsel to a wide variety of corporate clients. Please contact one of our attorneys to assist you with having an operating agreement drafted for the specific needs of your LLC, or for any other legal matter.