What is the Operating Agreement?
Once you have your company up and running, the next ideal step is to create an operating agreement. It gives structure to your operations by outlining your roles as well as financial responsibilities in the business. It also matches these roles with what’s best for the company going forward. Additionally, it gets into how much you own in the business and how much you can take home in profits. It also gets into how much loss you should shelter if the business ever gets to the point of going down that route. Moreover, it is here that you spell out your rights and those of other people in the organization. You also get to decide beforehand what would happen of one person decided to leave or if you all decided that the venture was not working. Generally, it is the guiding light for your venture and a lot can go wrong in its absence.
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Why does an LLC need an operating agreement?
You can think of this agreement as an internal document of guidance or insurance. Let’s look at it like we would a marriage. Suppose your spouse decides they want out of the union, what would happen next? For many people, there are no pre or post nuptial arrangements. That means that the separation and imminent divorce can get messy quite fast. With the piling legal fees coupled with intense emotions that surround such events, it can be quite stressful for you.
The same can happen with a business. If you lack guiding framework, it can get messy with people turning on each other. In a few weeks or months, your company’s reputation can suffer. You can probably think of businesses where owners fought it out in public, much to the chagrin of their clients. And not only that- you would spend a great deal of time arguing over things you can easily spell out in an agreement. The legal fees would also be quite high, causing further problems. Below are some reasons why getting an agreement in place would prove helpful to you when starting a multi-member or single-member LLC:
- It is advisable- As you start your venture, your attorney will likely suggest that you need an LLC operating agreement. Note, though, that the state will not ask you to provide one at any stage. However, in the event that anything goes wrong, you may need to offer one. The necessity of the arrangement is to provide a way out when something goes wrong. For example, if you have financial hardships and a member suggests something that does not sit well with you, the arrangement can be the way to solve this. It provides rules to which you can adhere and enforce. Additionally, it protects you from having to go the default route if anything goes wrong over time. Also, please note that this arrangement is not just for jointly-owned ventures but solo startups as well.
- Preservation- you need to have measures in place that benefit and protect you from being personally liable for debts accruing from the venture. An agreement can help you enforce this by laying down the operational rules. It is especially important to have one where you solely own the venture such that your protection is minimal. Without such an arrangement, the law can treat you as a sole proprietorship, thus deeming you personally liable for business debts. Thus, if you want to add a layer of protection around your business activities, it would suit you to follow this course.
- Financial Stability- things easily get complicated where money is involved. In due time, you will make many decisions on profits and their sharing patterns. You will also grapple with what to do upon the entry and exit of owners. Where an agreement is not present, personal interests can take the forefront, thus putting the venture at risk. You may find that you spend a great deal of time arguing instead of pushing the operations forward. It can also get so bad that you end up using default state laws that could hurt rather than help you.
- Default Rules- we have mentioned default rules a couple of times and you may be wondering what these are. Each state has its governing rules regarding business entities. These rules affect the business in two ways. In the first way, there are the general rules that apply to all business, regardless of the presence of agreements. You cannot bypass these as they form the framework of your operations such as how much you pay in taxes. The second lot is those that apply to entities that operate devoid of agreements. These come into play when you face a problem that you cannot solve as members, and require a third party to come and help with the issue.
Having difficulties in creating an Operating Agreement? Entrust this process to the Registered Agent who will create a document for you, taking into account the specifics of your business
How Can Be Drawn Up Virginia LLC Operating Agreement? Template
You have two choices in this case:
- You can hire an attorney to work on the documentation for you. Where you deal with highly specialized goods or work in an industry with many regulations, this would be the best option. The attorney can ensure that no loopholes are present that could land you in trouble.
- You can work on one based on free operating agreement templates available online. These feature the basics of such agreements and enable you to customize the operating agreement for LLC templates based on your business needs.
The document should include the following aspects:
- Basic information- this includes the name of the venture, where it is located and the address of the principal officer. It also includes supporting details where necessary.
- Purpose- this shows the intention of creating the business and what you will do once you get formal approval to start running the venture. This intent should be legal.
- Duration- it shows how long the operations will continue, which can include a termination date or the intent to continue in perpetuity.
- Taxing- you should indicate how you would like to file your taxes e.g. as a partnership, or any other entity.
- Entry- what procedures are in place to allow more people to join the venture? It applies even to solely run ventures.
- Membership- this clause shows who has ownership in the business and what positions they hold, as well as their addresses.
- Contributions- the arrangement should be clear on how much each person has brought to the venture and the value of this. It can be cash, services or other property of value.
- Raising Capital- as the venture grows, more capital may be necessary and it is imperative to get the processes clear from the start. For example, must members contribute to this?
- Profits & Losses- this section should show how and when people will receive their profits or losses.
- Voting- the rules should be clear on how voting should take place, including quorum considerations, number of votes per person and other such factors. Some people may have more voting power than others.
- Management- who will be in charge of the venture? How and when will they get paid? How will elections to seats take place? These and other aspects should be clearly shown.
- Duties- what services will members render to the venture and will they receive payment for this?
- Withdrawal- what happens if someone wants to leave? Are there grounds for expulsion and if so, what are they?
- Transfers- there may come a time when someone wishes to transfer their rights. What will happen in such a case?
- Deaths- who has the right to a dead member’s share in the business? Will members or next of kin be the first priority?
- Dissolution- this section should cover what happens if members decide to do away with operations for good.
Can you open an LLC without an operating agreement?
Yes, you are under no requirement to have an agreement in place. However, it is best that you have one for protection and peace of mind.
Disputes between Members in an LLC
Suppose members cannot seem to reach an amicable agreement, they can rely on the following dispute resolution methods, in absence of an operating agreement of LLC:
- Negotiation
- Mediation or Arbitration
- Litigation
They each have their pros and cons of which you should be aware before selecting any of them, hence the beauty of operating agreements LLC.
What Rules apply to an LLC without an Operating Agreement?
The applicable default law depends on the state. For example, in Default Judgment in Virginia, the state requires that profit and loss sharing be done based on an agreement or writing in the articles of organization. Where no operating agreement for an LLC is present, the sharing should take place based on the value of the contributions of each member. In this case, the rules may be favorable to the members. However, default definition laws tend to hurt rather than help ventures and it is best to avoid them altogether.
What is the default law?
All states in the USA have laws that apply to LLC operations. Some of these guidelines work in streamlining activities on a whole while others apply to business operations. In the absence of an agreement, the latter also become enforceable. These are the default law definitions.