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LLC 101 – Installment Four: The Operating Agreement

In addition to management and membership issues, the operating agreement for the limited liability company should also address various financial and other issues.

How will profits and losses be allocated among the members of the LLC and how will distributions be handled? One of the primary benefits of a limited liability company is the flexibility in the handling of financial issues. You can treat members differently based on the amount and types of their capital contributions. You can create preferential distributions for designated members. You can base distributions on capital accounts or another factor.

Will the members be required to make additional capital contributions to the LLC in the event of shortfalls, and if yes, who will make the decision on capital calls? With corporations, shareholders cannot be required to make additional capital contributions unless expressly provided in a shareholders agreement or similar document. With partnerships, partners are typically obligated to make additional capital contributions on a pro-rata basis. With a limited liability company, you can address this issue various manners. For example, you can require mandatory additional capital contributions based on pro-rata membership interests with the decisions made by a “majority-in-interest” of the members. You can alternatively provide that no member can be required to make a capital contribution, but include provisions for loans by members to the company to fund shortfalls.

In the event of the death of a member, should the company be obligated to purchase the interest of the deceased member? Should the company have the option of purchasing?

If a member must remain actively involved with the operations, management and/or marketing of the LLC in order for the company to be successful, should the company or remaining members be granted the right to buyout that member at a discounted price if the member no longer actively works for the company? These are just a few examples of issues that should be addressed in preparing your operating agreement. Some agreements may be simple, such as operating agreements for single member companies or married couples. Some may be complicated, such as operating agreements for LLCs with numerous investors with varying participation rights and obligations. Each company must be examined individually in order to determine the appropriate provisions to include. As with your first step, your final steps should also include consultation with your accountants and/or tax advisors.

Rick welcomes your questions about this article at RKBARRA@SCOTT-HARRIS.COM

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