It is no surprise that the LLC has become the most popular limited liability entity to form in the U.S. The flexibility afforded by the LLC structure is attractive to many entrepreneurs, especially small businesses. There’s one important step that owners of an LLC should not overlook: drafting the operating agreement. Today’s post highlights some of the main benefits of drafting an operating agreement for your LLC.
What is an Operating Agreement?
It’s a contract between the owners of the LLC (referred to commonly as “members”) and the LLC itself. The operating agreement includes terms that detail (among other things) the management rights, distribution of cash, allocation of profits of losses, and how members can join and exit the company.
Setting Clear Management Rights to Avoid Owner Disputes
One of the most important reasons to draft an operating agreement is to ensure the owners have clear expectations and a clear understanding of their management rights. The operating agreement gives you the ability to include management clauses that allocate management rights to one or more of the owners of the company. This allows for flexibility in divvying up management authority between the owners to make different decisions on behalf of the company. This can be especially helpful if the owners have different areas of expertise. For example, one owner may be especially adept at finances and operations, while another owner may be a marketing genius. Allocating different decision-making authority between the owners can create efficient management within your LLC.
Member Voting Rights
The operating agreement will also detail members’ voting rights. Different members can have different voting rights and different decisions can require different threshold of approval, e.g. unanimous versus majority. Having a written procedure for making decisions will reduce inefficiencies when it comes to making decisions on where to steer your company.
Non-competes and IP Ownership Rights
Many operating agreements will include clauses that spell out that members cannot compete with the LLC. These non-compete clauses must be drafted properly in order to be enforceable—which means the terms of the non-compete must be reasonable in scope and duration.
Another protection that is commonly included in an operating agreement is a clause that clearly details that the company owns all of the intellectual property conceived and developed on behalf of the LLC. Without an enforceable non-compete and IP ownership clause, an owner of the LLC may be able to take the LLC’s IP and start a competing company. Including these protections can save the owners from unnecessary conflict down the road.
How Members Join and Exit the LLC
Two significant sections of the operating agreement are the sections that detail how a member can join the company and how a member can exit the company or transfer his or her ownership. State laws generally have default rules on withdrawing and joining the LLC, and you can set your own rules for joining and exiting the company. Depending on the nature of your business and the relationship between the owners, it may benefit the company to have more (or less) flexible procedures for joining and exiting the LLC.
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