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An LLC operating agreement is one of the most crucial documents that will allow you to know the way a limited liability company will be operated and how vital decisions will be made. While not required in all states, it is crucial to have an LLC operating agreement that everyone agrees to, to avoid confusion and disagreement among members. But there are some common errors that business owners can make when drafting this document.
Here’s all you need to know about things to steer clear of.
Failing to Create an Operating Agreement
The single worst thing you can do is believe that you don’t need an operating agreement. State law may contain default provisions for an LLC, but not necessarily what the owners want. A written contract provides a chance for members to draw up their own process for managing, voting, bringing in profits, assigning responsibilities and more.
Using Generic Templates without Customization
There are lots of business people that make use of templates on the internet, as they are simple and affordable. But copying a generic document and making no changes to it to suit the business can mean important questions are not answered. Certain business requirements and financial terms, as well as the ownership and management structure of the LLC, should be included in the Utah operating agreement and business documents, and should not be solely dictated by one-size-fits-all language.
Not Clearly Defining Ownership Interests
An operating agreement should designate the nature of each member’s interest, as well as the percentage of ownership. If these details are not provided, there can be confusion regarding profit distribution, voting rights and financial contributions. The members should also make record of the occurrence of others contributing other funds or property to the company.
Ignoring Roles and Management Responsibilities
Another frequently made error is not assigning the authority for decision. An LLC can be a member managed or a manager managed LLC, and there needs to be a contract defining the powers and restrictions of the parties involved. Having a clear definition of authority will help to minimize conflicts with regards to contracts, funding, hiring, etc.
Overlooking Profit and Loss Distribution
Business owners should not take it for granted that profits will be divided on a pro rata basis. The agreement should also clarify the distribution of profits and losses and specify when distributions can be made. Members’ expectations can be better understood and disputes avoided if there are clear financial arrangements in place.
Forgetting Procedures for Major Changes
An operating agreement should be prepared to accommodate significant changes in the businesses. Owners should have protocols in place for adding members to the company, transferring ownership, when a member leaves the business, and for significant business decisions. If these are not in place, unpredictable circumstances can be hard to deal with.
Neglecting the Dissolution Process
Another overlooked aspect is the closing of the LLC. A good agreement will outline what happens to the company when it ends and how debts, assets and obligations will be dealt with. Having a process in place can help make an already difficult situation more orderly.
Failing to Review the Agreement
Making an operating agreement doesn’t have to be a one-time event. Ownership, business activities, business finances and management structures can change over time. The agreement should be reviewed from time to time by members and revised in case of change of important facts.
Final Thoughts
A well-drafted LLC operating agreement can help clarify, set expectations and minimize uncertainty among the owners of a business. If the document is not as clear as it can be, it is easier to make helpful suggestions about avoiding generic language, unclear ownership provisions, missing management rules, and inadequate exit procedures. If it is customized to fit the company’s specific needs and is revisited regularly, it can be a solid framework for future business activities.
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