Operating Agreement Checklist
Drafting an operating/partnership/shareholder agreement seems to be my most important but least utilized service. For whatever reason, business owners are very reluctant to spend the money on a well-drafted operating agreement tailored to their needs when they can download one for free. If you are a regular visitor to my site, you have read the horror stories about companies that settle for generic operating agreements or others that simply go without.
A couple of weeks ago I spent over an hour with two business partners trying to nail down the specifics for their operating agreement. One remarked, “wow, I had no idea so much went into these agreements.” I explained that so many things can go wrong when you’re in business with another person. The operating agreement’s purpose is to lay down some ground rules for managing the company and for resolving disputes so you don’t end up battling it out in court. Some states have default statutes that companies can rely on when they don’t have an operating agreement. Nevada isn’t one of those states. If you are in a dispute with your business partner and you don’t have an operating agreement, you must resolve it yourselves or let a judge decide. It’s called “judicial dissolution” and it is expensive and a huge distraction from your business.
Putting an operating agreement in place when you start your business is an investment worth making. Here are some things you should consider:
LLC Operating Agreement Checklist
The American Bar Association has published a 120-page long operating agreement checklist. The following checklist is therefore not completely comprehensive but addresses most of the concerns my clients face.
GENERAL INFORMATION
Name of LLC
LLC Purpose
Principal Place of Business
Name and Address of Registered Agent
Name of Tax Matters Partner
Manager Managed or Member Managed?
Tax Treatment?
__Disregarded entity
__Partnership
__Subchapter S Corporation
__Subchapter C Corporation
MANAGEMENT
Member-Managed or Manager-Managed LLC?
If Manager Managed…
Must the Managers also be Members of the LLC? ___ Yes ___ No [usually no]
Are Managers to be elected? ___ Yes ___ No [usually no]
If yes, by what vote? __unanimous __75% __2/3rds __majority __other:
Are the Managers to be paid? How so?
Names of Members or Managers
Name:
Name:
Member or Manager?
Member or Manager?
Address:
Address:
Capital Contribution:
Capital Contribution:
Member or Manager?
Member or Manager?
% Interest in LLC
% Interest in LLC
Voting Rights
Voting Rights
Roles and Responsibilities
Roles and Responsibilities
Name:
Name:
Member or Manager?
Member or Manager?
Address:
Address:
Capital Contribution:
Capital Contribution:
% Interest in LLC
% Interest in LLC
Voting Rights
Voting Rights
Roles and Responsibilities
Roles and Responsibilities
- Do you wish to provide for different “classes” of Members __Y __N
- Who can vote and who cannot vote?
Amendments of the Operating Agreement which directly change the financial share of each Member will require unanimous consent. Do you wish to provide for other types of amendments with less than unanimous consent? __Y __N If so, what consent: __75% __2/3rds __other:
- A decision to dissolve the LLC is to be made by the following vote: __unanimous __75% __2/3rds __majority __other:
With regard to whether a Member may engage in competing business activities:
__the Operating Agreement is to be silent on the subject;
__Members are expressly to have the right to engage in competing businesses;
__each Member is to covenant not to compete while a Member and for period after membership in the LLC ceases – enter time period and geographical area:
CAPITAL CONTRIBUTIONS
Are additional contributions required of all Members?
Are additional capital calls permitted? __Y __N
Who can make the capital call?
Must there be a specific instance or circumstance or process?
If a call is made, members must contribute __equally __pro rata
Within _______ days/weeks/months or
Within the time period specified in the call notice
What happens if a member does not meet expected contributions?
Potential consequences:__Reduction in share of profits, __Reduction in share of profits and reallocation of capital, __Preferential distributions to other members, __Loan from company at %, __Loan from non-defaulting member (and interest rate), __Personal liability on the part of member, __Opportunities for other members to make up and defaulting member is diluted, __Suspension of management authority or voting rights, __Right to purchase defaulting member’s interest in the LLC, __Forfeiture of defaulting member’s interest in the LLC, __Automatic diversion of distributions to make up deficit (lien like)
Is there a mechanism for “cashing out” a member?
How do you value the contribution of the member up to the point of withdrawal?
Can the member stay a member even if he/she is no longer actively managing the business or delivering consulting services?
ADMISSION OF NEW MEMBERS
May new Members be admitted to the LLC with LESS THAN unanimous consent? ___ Yes ___ No [usually no]
If yes, what consent: __75% in interest __2/3rds in interest __majority in interest __other:
- If a Member desires to voluntarily withdraw, must the Member first get the consent of some or all of the other Members? ___ Yes ___ No
If yes: __unanimous consent __75% in interest __2/3rds in interest __majority in interest __other:
Are the names and addresses of all of the Members to be recited in the Articles of Organization of the LLC? ___ Yes ___ No
Is the Operating Agreement to provide for assignment of allocations and distributions to:
__relatives of a Member without consent;
__another Member without consent;
__to any person with the following consent:
__no consent required
__unanimous (all Members) __75% __2/3rds __majority __other:
DECISION-MAKING
In general, decisions reserved to the Members are to be made by what vote: __majority __2/3rds __75% __unanimous __other:
In addition to generally authorizing the Managers to handle daily operations of the LLC, is the Operating Agreement to expressly give the Managers broad and detailed powers? __Y __N
How will salary and earnings distributions be made?
TERMINATION OF MEMBER
Voluntary Transfer
What happens if a Member wants to leave the company?
__Prohibited
__ Permitted but assignee is not admitted as a member without the consent of _____% of the other members
__Permitted only with consent of ____% of the other members
Is company given right of first refusal?
How long following notice from leaving member must company decide whether to purchase the member’s interest?
Can the Member sell his/her interest __ to anyone __only to existing members?
Are the other Members to agree, in advance, to buyout the interest of a Member who dies or becomes totally disabled (or retires)? [usually no] __Y __N
If yes, check one of the following:
__buyout on death
__buyout on disability
__buyout on retirement
__insurance for death or disability is to be maintained by the Members to pay the purchase price
Interest transfers to spouse/next of kin?
Company can purchase interest at fair market value?
Life insurance funded buyout provision?
Involuntary Transfer
__Gross negligence
__Bankruptcy
__Disability; if so, definition of disability:
__Guardian/conservator appointed by court
__Primary care physician or designee determines inability to manage business affairs
__Member has not performed business functions for ____ days
__No performance of duties for Company in ____ days
__Agent pursuant to power of attorney notices Company of disability
__Willful misconduct
__Conviction of a crime
__Conviction of a crime against the Company
__Violation of the operating agreement:
__Any violation
__Material violation
__Repeated violation
__Violation of particular provisions:
__Other:
Who determines?
__All of the members
__% of the members
__All of the members other than the member being removed
__Other:
How is the purchase price determined?
Company CPA valuation?
Multiples of earnings based on most recent tax returns?
Independent valuation?
- REMOVAL OF MANAGER
- Removal only for cause? __Y __N
- __Gross negligence
- __Bankruptcy
- __Disability; if so, definition of disability:
- __Guardian/conservator appointed by court
- __Primary care physician or designee determines inability to manage business affairs
- __Member has not performed business functions for ____ days
- __No performance of duties for Company in ____ days
- __Agent pursuant to power of attorney notices Company of disability
- __Willful misconduct
- __Conviction of a crime
- __Conviction of a crime against the Company
- __Violation of the operating agreement:
- __Any violation
- __Material violation
- __Repeated violation
- __Violation of particular provisions:
- __Other:
- Who determines?
- __All of the members
- __% of the members
- __All of the members other than the member being removed
- __% of the members other than the member being removed
- __Other:
- Removal only for cause? __Y __N
- DISSOLUTION OF COMPANY
How is left-over cash distributed?
How and by whom are liabilities paid?
How are non-cash assets disposed of?
GOVERNING FORMALITIES
If the LLC is to be managed by Managers who are not Members, is the Operating Agreement to provide for annual meetings of the Members? __Y __N
Are disputes to be resolved by arbitration? __Y __N
If Manager-Managed, is the Manager required to provide: __monthly reports __quarterly reports __both
Who retains possession of the corporate book?