Operating Agreement Checklist

checklistDrafting 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.

  1. GENERAL INFORMATION

    1. Name of LLC

    2. LLC Purpose

    3. Principal Place of Business

    4. Name and Address of Registered Agent

    5. Name of Tax Matters Partner

    6. Manager Managed or Member Managed?

    7. Tax Treatment?

      1. __Disregarded entity

      2. __Partnership

      3. __Subchapter S Corporation

      4. __Subchapter C Corporation

  2. MANAGEMENT

    1. Member-Managed or Manager-Managed LLC?

    2. If Manager Managed…

      1. Must the Managers also be Members of the LLC? ___ Yes ___ No [usually no]

      2. Are Managers to be elected? ___ Yes ___ No [usually no]

        1. If yes, by what vote? __unanimous __75% __2/3rds __majority __other:

      3. Are the Managers to be paid? How so?

      4. 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

    3. Do you wish to provide for different “classes” of Members __Y __N
      1. Who can vote and who cannot vote?
    4. 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:

    5. A decision to dissolve the LLC is to be made by the following vote: __unanimous __75% __2/3rds __majority __other:
    6. 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:

  3. CAPITAL CONTRIBUTIONS

    1. Are additional contributions required of all Members?

    2. Are additional capital calls permitted? __Y __N

      1. Who can make the capital call?

      2. Must there be a specific instance or circumstance or process?

      3. If a call is made, members must contribute __equally __pro rata

        1. Within _______ days/weeks/months or

        2. Within the time period specified in the call notice

    3. What happens if a member does not meet expected contributions?

      1. 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)

    4. Is there a mechanism for “cashing out” a member?

    5. How do you value the contribution of the member up to the point of withdrawal?

    6. Can the member stay a member even if he/she is no longer actively managing the business or delivering consulting services?

  4. ADMISSION OF NEW MEMBERS

    1. 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:

    2. 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:

    3. Are the names and addresses of all of the Members to be recited in the Articles of Organization of the LLC? ___ Yes ___ No

    4. 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:

  5. DECISION-MAKING

    1. In general, decisions reserved to the Members are to be made by what vote: __majority __2/3rds __75% __unanimous __other:

    2. 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

    3. How will salary and earnings distributions be made?

  6. TERMINATION OF MEMBER

    1. Voluntary Transfer

      1. 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

      1. Is company given right of first refusal?

      2. How long following notice from leaving member must company decide whether to purchase the member’s interest?

      3. Can the Member sell his/her interest __ to anyone __only to existing members?

      4. 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

        1. If yes, check one of the following:

          1. __buyout on death

          2. __buyout on disability

          3. __buyout on retirement

          4. __insurance for death or disability is to be maintained by the Members to pay the purchase price

      5. Interest transfers to spouse/next of kin?

      6. Company can purchase interest at fair market value?

      7. Life insurance funded buyout provision?

    1. Involuntary Transfer

      1. __Gross negligence

      2. __Bankruptcy

      3. __Disability; if so, definition of disability:

        1. __Guardian/conservator appointed by court

        2. __Primary care physician or designee determines inability to manage business affairs

        3. __Member has not performed business functions for ____ days

        4. __No performance of duties for Company in ____ days

        5. __Agent pursuant to power of attorney notices Company of disability

      4. __Willful misconduct

      5. __Conviction of a crime

      6. __Conviction of a crime against the Company

      7. __Violation of the operating agreement:

        1. __Any violation

        2. __Material violation

        3. __Repeated violation

        4. __Violation of particular provisions:

        5. __Other:

      8. Who determines?

        1. __All of the members

        2. __% of the members

        3. __All of the members other than the member being removed

        4. __Other:

    2. How is the purchase price determined?

        1. Company CPA valuation?

        2. Multiples of earnings based on most recent tax returns?

        3. Independent valuation?

  1. REMOVAL OF MANAGER
    1. Removal only for cause? __Y __N
      1. __Gross negligence
      2. __Bankruptcy
      3. __Disability; if so, definition of disability:
        1. __Guardian/conservator appointed by court
        2. __Primary care physician or designee determines inability to manage business affairs
        3. __Member has not performed business functions for ____ days
        4. __No performance of duties for Company in ____ days
        5. __Agent pursuant to power of attorney notices Company of disability
      4. __Willful misconduct
      5. __Conviction of a crime
      6. __Conviction of a crime against the Company
      7. __Violation of the operating agreement:
        1. __Any violation
        2. __Material violation
        3. __Repeated violation
        4. __Violation of particular provisions:
        5. __Other:
    2. Who determines?
      1. __All of the members
      2. __% of the members
      3. __All of the members other than the member being removed
      4. __% of the members other than the member being removed
      5. __Other:
  2. DISSOLUTION OF COMPANY
    1. How is left-over cash distributed?

    2. How and by whom are liabilities paid?

    3. How are non-cash assets disposed of?

  3. GOVERNING FORMALITIES

    1. 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

    2. Are disputes to be resolved by arbitration? __Y __N

    3. If Manager-Managed, is the Manager required to provide: __monthly reports __quarterly reports __both

    4. Who retains possession of the corporate book?