You have decided to form a Limited Liability Company (LLC) – you have chosen a name, filed Articles of Organization with the State Corporation Commission and paid the initial filing fee, appointed a registered agent, and obtained an EIN – so you must be ready to do business now, right? Not so fast! Although Virginia does not require that an LLC prepare an Operating Agreement, failing to prepare one could surely be a fool’s move.
If an LLC isn’t required to create an Operating Agreement, one may wonder why time and effort would be put into that after already completing the myriad items required to form the LLC in the first place. That’s a fair question, but the importance of an LLC operating agreement cannot be overstated – it is the document that structures the management, financial, and general functional decisions and operations of the entity, and, once signed, is a binding contract among the LLC’s members. In addition to providing the LLC’s overall structure, an operating agreement ensures that all members are clear on the terms and conditions of the LLC and, perhaps most importantly, serves to protect the members from personal liability.
While it is now clear that an LLC operating agreement is, indeed, an essential component to the creation of an LLC, as it is not mandated in Virginia, there are not any required components of provisions of the document. However, the core components of an LLC operating agreement generally include provisions regarding (1) the financial structure of the LLC; (2) how the LLC will be managed; (3) members’ voting rights and requirements; (4) limitation of liability (the whole point of an LLC!); (5) transfer of members’ interests; (6) termination or dissolution of the LLC; and (7) dispute resolution. Each of these general provisions are discussed in more detail below.
Core Components of an LLC Operating Agreement
Financial Structure of the LLC
How will the LLC be taxed? If a single member LLC, it may be taxed as a “disregarded” entity; if a multi member LLC, will it be taxed as a partnership, an S Corporation, or a C Corporation?
What are the capital contribution requirements, if any, and what are the contributions of each member? Are the contributions in the form of services, property, cash, a guaranty, etc.?
What is each member’s ownership percentage (to be determined by each member’s capital contribution)?
Do the members seek to allocate profits and losses in some manner other than in proportion to each member’s ownership interest?
Will the LLC be Member-Managed or Manager-Managed? If it will be Member-Managed, or if it is otherwise not specified, then each member will have management rights. If Manager-Managed, consider how the manager(s) will be appointed; what the term length will be; and how anyone may be removed or replaced? What will the manager(s)’ roles, duties, and responsibilities be?
What fiduciary duties do the LLC managers have and what is the extent of the managers’ duty of care? If these duties are breached, what are the consequences?
How and where will the LLC’s books and records be maintained and made available to LLC members?
What types of decisions must be voted on by the members? Some examples include: Mergers, sales, reorganization, dissolution, or bankruptcy of the LLC; amendments to the operating agreement; transactions over a certain threshold value or seeking loans in excess of a certain threshold amount; and admission of new members.
Similarly to how profits and losses may be allocated in a manner other than in proportion to a member’s ownership interest, a member’s vote may also be altered so as to not be in proportion with his/her ownership interest.
Will certain managers or members have veto rights during a vote?
Transfer of Membership Interests
Will members be able to assign their membership interest to someone else? And, if so, will such assignment include the member’s management rights, if any?
If a member seeks to transfer his/her interests, must all members consent to the transfer? And, may the LLC or other members have “the right of first refusal” – that is, the right to match a 3rd party’s bona fide offer for the membership interest?
Will there be any circumstances or events in which the LLC or other members may opt to buy-out a particular member? If so, it is important to describe in detail the events giving rise to a buy-out option, the specific buy-out procedure, and the price and payment terms of the same.
Termination or Dissolution of the LLC
Will a particular individual be able to dissolve the LLC? Or will certain events automatically trigger dissolution?
What law will govern the operating agreement and any disputes stemming from that agreement (choice of law)?
How will a dispute be decided (arbitration, or litigation, for example)?
Will the losing party be responsible for the legal fees of the prevailing party?
As our firm has advised clients on, and subsequently drafted, numerous operating agreements for a wide variety of LLCs, if you are thinking about creating an LLC and need an initial operating agreement or, perhaps, if you have a current LLC operating agreement but are unsure if it best meets and protects the needs of the LLC, please do not hesitate to call us!