Why a California LLC Needs a Written Operating Agreement
Legal formalities are often the last thing entrepreneurs and business owners want to think about. But ensuring an LLC follows the formalities, like having an operating agreement, is crucial to prevent potential legal headaches.
What is an Operating Agreement?
An operating agreement is a legal document that typically contains the ownership, structure, management, decision-making process, and operating procedures for an LLC.
Importance of a Written Operating Agreement
Recording Ownership Percentages (For LLCs)
An Owner of an LLC is called a “member.” A California LLC’s operating agreement records the amount of the LLC that each member owns. This is important because it serves as evidence of each member’s ownership interest in the LLC, which affects voting and profit distribution rights.
Maintaining Limited Liability Protection for Owners
An LLC is a separate entity from its owners. The members of an LLC are generally not personally liable for the LLC’s debts, obligations, or liabilities. But this limited liability shield can be “pierced” if a court finds that the LLC is not a separate entity from its members. An operating agreement helps establish the LLC as a separate legal entity and maintain limited liability for the members.
Establishing Powers and Duties of Managers and Members
LLCs can be member-managed or manager-managed. For member-managed LLCs, the agreement outlines each member’s operational responsibilities. In manager-managed LLCs, it defines the authority of appointed managers.
Preparing for a Sale of the LLC
Investors and prospective buyers of an LLC will almost certainly request the LLC’s operating agreement while conducting due diligence. If the LLC does not have a written operating agreement, that may slow down the sale or cause an investor or buyer to walk away altogether.
Resolving Owners’ Disputes
An operating agreement can help prevent and resolve disputes between members. The agreement can prevent disputes by serving as evidence of each member’s rights and responsibilities. And an operating agreement can contain instructions for how to address disputes, such as a third-party vote to overcome a voting deadlock between members with equal voting rights, or requiring mediation or arbitration to avoid costly litigation.
The text above is intended for informational purposes only and is not legal advice. For advice tailored to your situation, please consult with an attorney.