“My Banker Says I Need an ‘Operating Agreement.’ What is that?”
By: Jason Simmons | Published September 26, 2016
Oftentimes, new business clients will contact the office saying that they were referred by their banker who tells them that they need an operating agreement. Inevitably, one of the first questions that they have is “what is an operating agreement?”
An operating agreement is, quite simply, an oral or written contract among the members of a limited liability company that defines how the company is going to be operated and how the relationship among the members is to be governed. It is similar to a partnership agreement for a state-law partnership. It is also much like a shareholders’ agreement for a corporation.
The Missouri Limited Liability Company Act requires an LLC with two or more members to have an operating agreement. If the LLC has only one member, the Missouri Limited Liability Company Act requires a “written declaration” by the sole member. From a practical standpoint, I always recommend to clients that they have a written operating agreement, even if it is not otherwise required where there are multiple members. The written operating agreement will reflect what the agreement among the members was at the time it was signed and can be an objective measure of what was intended by the members.
There is no specific formula as to what should be included in an operating agreement, although the statutes do highlight some things that should be included, or that the LLC is required to maintain in writing if it is not included in an operating agreement. If there is only one member, or if the members of an LLC are married, the terms are likely to be more simple. This is because there is less issue for conflict, or if there is conflict between married persons, it is likely that the ownership of the LLC would be resolved in the property settlement and divorce decree. In situations where there are multiple members and they are not married, the operating agreement becomes even more important.
Some of the more detailed provisions that will be included in an operating agreement for multiple members include the following:
• How will the LLC be managed? If by a manager, what authority does the manager have?
• How will capital be raised?
• Will member loans be permitted?
• What voting levels are required?
• How will distributions be determined?
• What happens upon the death of a member?
• What will constitute an event of voluntary or involuntary withdrawal?
• Will the members have a right of first refusal, put options or call options?
• How will the members be restricted, if at all, in transferring their membership interests?
• How will substitute or additional members be added?
• How will the LLC be valued?
• How will a management deadlock be handled?
These are just a few of the many topics that can be included in an operating agreement. The important thing to remember, from my perspective, is that since it is a contract, it really defines what happens when the members and other interested persons are not able to agree on how they want to handle something – such as a buyout upon the death of a member. Because it is a contract, it can almost always be amended and the parties can agree to handle things differently. The operating agreement basically states what is supposed to happen when the parties do not agree or cannot get along. Of course, an operating agreement is central to any successful business succession plan.
If you do not have an operating agreement for your LLC, or if you have one but think that changes might be necessary to address your business succession planning goals, feel free to give Cripps & Simmons a call. We would be happy to meet with you and help prepare an operating agreement that meets your needs and goals.