What are the Elements of an Operating Agreement?
An Operating Agreement (OA) provides explicit terms regarding the financial and operational rules of a limited liability company (LLC). While most states don’t require this document to create an LLC, it’s a vital business document for LLCs that intend to be a part of more complex transactions like buying and selling real estate.
Benefits of an Operating Agreement
For LLCs consisting of more than one member, the document also helps to prevent misunderstandings. Even when dealing with trustworthy partners, oral agreements can be misinterpreted. Having a written OA clarifies any questions about how to handle daily business matters, establishes the structure of the company, and outlines the roles of members and managers.
Additionally, leaving the details of an LLC’s operations up to default state rules means that any printed, oral, or inferred agreement may be used in the future if a dispute arises. Ambiguity opens up an LLC to risks like lawsuits. Proactively addressing the practices of the LLC in a written document will offer members peace of mind.
Accessing loans and investment opportunities is much easier when an LLC has an OA and other entity documents completed.
What’s Included in an Operating Agreement?
- Voting power and rules for meetings
- Members’ and Managers’ rights and responsibilities
- Joining and exiting the LLC
- The transition of ownership and dissolution
One of the first elements to address is that of ownership. This portion explains how the LLC’s profits, losses, and assets are divided among its members. Each member’s ownership is expressed as a percentage. In the case of single-member LLCs, the percentage will be 100%.
Voting Power and Rules for Meetings
There are two common approaches taken for LLC voting rights:
- Each member’s vote is weighted depending on their percentage of ownership
- Each member gets one vote of equal weight regardless of their ownership percentage
If an LLC decides to implement the first approach, ownership percentages determine who holds the most sway. Conversely, ownership percentages become less influential when adopting the latter approach.
The frequency of meetings, who can call special meetings, whether notice must be given, and who is entitled to join certain meetings is usually outlined in the OA.
Members’ and Managers’ Rights and Responsibilities
The OA should also address the division of labor among members and define each one’s role. Unlike a corporation, most states don’t require an LLC to have officers. However, if an LLC wishes to appoint one or more individuals with the power to represent the company, it should be clearly outlined in the OA.
Depending on the size of the LLC and number of members, other roles may include:
- A chairperson who presides over managers’ meetings
- A president to take charge of daily operations
- A secretary to maintain business records and oversee meetings
- A treasurer to control the financial accounts and manage the taxes
Additional roles may be created based on each member’s expertise and the needs of the LLC. This provision provides an excellent tool for dispute resolution because it outlines which member is responsible for making the final call in a specific area.
Often, the OA will establish managers, who may or may not be members of the company, for the purpose of handling the business affairs of the company. The scope of the authority of those managers can be established in detail in the OA.
Joining and Exiting the LLC
If a member decides to leave or a new member wants to join, the OA should provide the protocol for the next steps. What is the onboarding process like and how will the new member’s investment fit within the LLC’s current ownership agreement?
The rules for an exiting member may be dictated by state law. In certain states, the exiting of a member may require the dissolution of the entire LLC. If the LLC is not dissolved, what is the member entitled to receive?
Transition of Ownership and Dissolution
Without an OA, if an unfortunate event results in the deaths of the members or a single-member LLC loses its only member, the state may require the LLC to be dissolved after a certain timeframe. The OA often includes a provision to pass membership rights from one person to another upon death.
If the members of an LLC decide to dissolve it, the OA should also detail the terms for how to pay off the LLC’s debts, divide remaining assets, and establish whether former members may create and run new companies like the dissolved LLC.
Avoid a “One Size Fits All” Operating Agreement
Before drafting an operating agreement, it’s a good idea to consult with an attorney to ensure the unique aspects of the LLC are captured in the final OA. A legal professional will be able to sit down with all the members and hash out the details to properly prepare this document. Copying and pasting “standard” or “boilerplate” OA language from online sources may result in unintended consequences.
What Happens if an LLC Doesn’t Have an Operating Agreement?
If an OA is not created, the default rules established by your state’s statutes will apply. This may not present too much of an issue, but drafting an OA unique to your LLC provides more control and flexibility.
In states like California, Missouri, and New York, the OA t must be included during the incorporation process. Check the requirements of your state before filing.
Why Is an Operating Agreement Needed for a Real Estate Transaction?
At Blueprint, we ask for entity documents like the OA to better facilitate your real estate transaction. As mentioned above, the OA provides important details about the rights and responsibilities of LLC members. When working with LLCs comprised of multiple members, the OA spells out exactly which members have the right to act on behalf of the company. Having this information at hand prevents delays in the closing process as additional documentation and the signature of members and/or managers with signing authority may be required to resolve issues encountered along the path toward closing.
If an LLC doesn’t have an OA and is comprised of one member, an affidavit may be provided in lieu of the OA. Contact email@example.com to learn which document is required for your transaction.