Establishing your business as a Limited Liability Company (LLC) is a highly effective means to protect your assets in the event of a legal dispute. As a formal structure, founding an LLC allows businesses to combine the taxation laws of a sole proprietorship with the limited liability of a corporation.
After determining that an LLC is right for your business, it is crucial to establish an official operating agreement to ensure all members of the organization understand their roles and responsibilities. Shawn Khorrami, the Founder of Khorrami Consulting, has a list detailing five key factors to take into consideration when drafting an LLC operating agreement and briefly outlines them below.
The first factor that must be taken into consideration is the details surrounding the members who are partaking in the agreement – the partners. You must be able to determine precisely how many individuals are participating in this operating agreement in the present time, as well as their particular names and titles; all of this must be stated clearly.
Also, you will need to determine if your agreement needs to factor in the addition of new members in the future, should the need arise. All present members should unanimously agree with the notion of expanding the roster of members.
Structure Of Management
It is also essential to outline the details of the management structure in the agreement to specify roles and responsibilities. Businesses can either agree that the members of the LLC manage the company (also known as member-management), and take care of daily operations themselves, or you can appoint a committee to run the business instead (also known as manager-management), where the members in your agreement take a more hands-off approach as other individuals manage the daily aspects of the company. Taking the time to identify various roles will ensure all members understand the authority they (may or may not) have.
Next, you will need to outline the investments that each individual member is contributing to the company. For each member, their investments may be in the direct form of cash, properties used as collateral, or services rendered; each of these types must be specifically stipulated and clearly attributed to the respective individual.
According to Shawn Khorrami, it is also good practice to think ahead and consider the possibility of a member who wishes to leave the company and cash out their portion of the investments. Set specific terms that outline exactly how this process will occur, including the possibility of a buy-out, specifically whether or not the terms for a member-to-member buyout will differ from a third-party buyout.
When it comes to how your LLC is taxed, there are several options at your disposal that are dependent on the number of members partaking in the agreement. In the case of a sole member, you can opt to be taxed as a sole proprietorship. If there are multiple members, you can choose to be taxed either as a partnership or as a corporation; as always, ensure that all members agree about the method of taxation.
Sharing Of Profits
Finally, it is essential to have a section in your agreement dedicated to the distribution of profits within your LLC amongst its members. A traditional arrangement for this is to have each member’s share of the profits be directly connected to their percentage of interest within the company; with that being said, you will need to ensure that the arrangement in your LLC is agreed upon unanimously, and you should be prepared to make amendments.
In addition to the amount of profits that are distributed between members, the frequency of this distribution should also be included in your agreement. One key factor that will play a role in exactly how often profits are distributed is taxation: The profits within an LLC are taxed to its members, and you will need to ensure that profit distributions will be able to pay off these taxes.
While there are many other factors and issues that can be addressed in an operating agreement, these are some of the essentials that need to be considered.
As a serial entrepreneur, Shawn Khorrami has strongly developed skills of both adaptability as well as tenacity, having handled many large-scale legal cases in addition to starting up and investing in businesses within a variety of industries.