The LLC Operating Agreement – Write it, with the Right Terms in it- Part II
Management is always a key issue; if there is only one member or it’s a husband and wife team, then having the members manage is not a problem. But what if there are multiple members either now or expected in the future; perhaps then you want a manager to manage. One of the members can act as manager; alternatively, a non-owner, a non-member can act as the manager.
You need limits on the manager’s authority, perhaps dollar limitations. Certainly, the manager cannot take action which is not in the ordinary course of business, unless authorized by a proper vote or consent by the members. The agreement must set forth a mechanism for terminating the manager’s authority, even if the manager is a member and will remain a member after the manager is replaced.
Distribution of money also is a critical issue; distributions may be based simply on membership interests. But it can get a little more complicated. What if there are the two of you, and you want to maintain majority control as a member, but want to share distributions with your other member on an equal, 50/50 basis. This can be done; one means is to have voting membership interests as well as non-voting membership interests; in all other respects, the membership interests may be the same. You have the majority of voting membership interests; your other member holds a minority voting interest. Let’s say you hold 60 % of the voting interest; he or she holds 40 % of the voting interest. But he or she holds 60 % of the non-voting interest, while you hold 40% of the non-voting interest. Distributions would be based on total membership interest, and each of you holds 50% of the total membership interest, so the distributions are equal, although you hold the majority vote.
In some circumstances, one member needs to be bought out, either by the other members or by the company. You need to spell these circumstances out clearly. The circumstances may include death or disability, and often include bankruptcy or insolvency and creditor attachment. If the members also are employees of the company, you may want to provide that in the event the member’s employment terminates for any reason, then the departing member’s interest will be bought out by the company or the other members.
You need to set out the means of determining the purchase price of the departing member’s interest and the manner of payment. You can set an agreed-upon price in the operating agreement, which price may be adjusted by agreement periodically. Alternatively, you can set out a formula for determining the price or name an acceptable appraiser who will value the interest at the right time and then set the price.
Restrictions on Member’s Transfer of their Interest
Common is the provision restricting a member’s ability to transfer their interest to a third-party; often the company and the other members have a right of first refusal – a right to buy the interest at the price offered by the third-party. Only if the company and the other members decide not to exercise the right of first refusal will the selling member have the right to sell the interest to the third-party. The third-party can step in as a new member, only if he or she agrees to the terms of the operating agreement.
A comprehensive operating agreement can run more than 20 pages; it takes some time to read and fully digest. But it is invaluable if a dispute arises; it is invaluable if there is a difference in the members’ recollections as to how some matter is to be addressed. It does what every good agreement should do – it sets the parties’ expectations, or perhaps more accurately, it confirms their expectations – their expectations and understandings about how their company is to be run. And with their expectations made clear, they can focus on business, and that is a good thing.
This is not intended to be legal advice for any specific situation and the reader should consult their attorney regarding their situation.