Does Your LLC Operating Agreement Create Unnecessary Risks?
Among small business owners, LLCs are the most common incorporation model. That’s because, while the model provides valuable asset protection, it’s also quite easy and affordable to form an LLC – typically there’s a small fee and some paperwork involved.
Perhaps the most surprising distinction between different states’ requirements, though, is that many states don’t require LLCs to file an operating agreement, despite the fact that the U.S. Small Business Administration considers this agreement to be one of the most important documents for multi-member LLCs. You can, however, always create one.
Whether you’re required to file an LLC operating agreement by your state or you simply decide that you should, it’s important that your agreement protects your business, rather than creating unnecessary risks. To that end, when developing an operating agreement, it’s important to keep these 3 issues in mind.
Often LLC documents are drawn up before businesses have a complete picture of their future plans. To this end, many leave a certain amount of ambiguity in their operating agreement – it leaves the door open to new activities and opportunities.
Unfortunately, whenever there’s ambiguity in an operating agreement, there’s also room for exploitation in the event of a disagreement. Remember, you can always revise your operating agreement if you want to change direction, but when left as is, that initial ambiguity can always work against you.
Don’t Get Buried In Boilerplate
When LLCs are required to file an operating agreement, many opt for a free, fill-in-the-blank style document. It keeps expenses to a minimum and, as long as you’re willing to assume that everyone will share profits and losses equally and no one has any special roles or commitments, that’s a fine approach. For more complicated agreements, though, these free documents just aren’t enough.
You can avoid taking on too much risk in situations with unequal responsibilities or losing out on other important protections by opting for a customized LLC operating agreement rather than a free document. It will cost a little more, but it’s worth it to avoid the vulnerabilities stemming from a boilerplate document.
Failure To Revise
As noted above, it’s important to revise your LLC’s operating agreement whenever you make any important changes to your business, but that’s not the only time you need to update the document. Sometimes changes to state or federal law also necessitate revisions.
For example, changes to federal income tax rules have changed how partnerships are taxed. Depending on operational preferences, your business may need to revise its operating agreement to redistribute how that tax burden is allocated.
Whenever you’re offered a boilerplate option for a legal document, it’s important to understand that it’s unlikely to provide you with the kind of protection that a customized version would; such basic forms are only meant for the simplest circumstances. As you draw up your operating agreement, then, it’s important to look for places where members’ actual rights and responsibilities split off from what’s outlined in the basic document. Or, better yet, consult a lawyer. They can fill in the blanks and nuances in a way that provides you with the maximum of rights and protections.