An operating agreement is the corporate governance document of a limited liability company (“LLC”). The operating agreement is a contract between the members (the founders of the LLC) that governs the organization and operation of the LLC. The operating agreement defines how the affairs and conduct of the business are to be done.
Michigan does not require an operating agreement, and provides statutory provisions for LLC’s that lack an operating agreement. Both single and multi-member LLCs may have an operating agreement. There are several reasons to have an operating agreement- investors and lenders usually want to see one, the place controls upon the members to prevent a member from damaging the LLC through unilateral action, and so forth.
The Benefits of Having an Operating Agreement
There are many benefits to having an operating agreement. Some are business-specific, while others are general benefits. Below are discussed some general benefits.
First, the operating agreement spells out how the limited liability company is to be run. For example, it spells out what requires a vote. The operating agreement should reflect a balance between control and flexibility. Expenditures are one element that often requires a vote, but the question arises, what level of expenditures? Businesses need the flexibility to make purchases without approval, but also want to ensure expenditures are proper, necessary or not excessive. This, an operating agreement can spell out an amount over which a vote is required: for example, any expenditure greater than $500 requires the vote of the members of the LLC. This allows the business to make day-to-day expenditures without the hassle of a vote, but also allows expenditures greater than $500 to require a vote, thus keeping tabs on the outflow of funds.
Second, the operating agreement can prevent a member from selling their interest to an outside party. Often, the members of an LLC are on the same page in regards to the business and its operations. The members do not wish an outside party to become a member. Thus, an operating agreement can spell out what happens if a members wishes to sell their interest. For example, the members’ relationship may sour, and one or more members may wish to exit the LLC. The remaining members may not want the selling member to sell their interest to an unknown outside party. The operating agreement can spell out a method for the remaining members to purchase the selling members’ interest. This operates to keep control amongst the remaining members.
Third, the operating agreement can spell out what happens in the instance of the death of disability of a member. These provisions are usually similar to what happens when a member wishes to sell their interest. If, for example, a member passes away, the remaining LLC members likely wish to retain control and not admit an outside party, and the operating agreement can spell out how the interest of the deceased member are to be purchased.
Fourth, the operating agreement can spell out the right to distributions. When do members get distributions from the LLC? Members obviously want profits from the business, but taking distributions should not inhibit or danger the operations of the business. The operating agreement also spells out the total membership interests of the members (does one member own more of the LLC than other members), and thus, does the member with more interest get a great distribution?
There are many other considerations that go into drafting an operating agreement. For example, of the LLC is managed by a manager rather than its members, the operating spells out the rights and responsibilities of the manager(s). If your LLC lacks an operating agreement, or for a review of your current operating agreement, please contact Benjamin Long of Schmidt & Long.