Key Provisions to Address in Your LLC Operating Agreement

A limited liability company (“LLC”) has become the preferred entity of choice for new business ventures since the State of Wisconsin adopted legislation in 1993 (hereinafter referred to as the “LLC Act”) which enabled Wisconsin businesses to organize a limited liability company (hereinafter referred to as “LLC”). The operating agreement (“Operating Agreement”) for an LLC is the statutorily recognized contract between the owners of an LLC (referred to in the LLC Act as “Members”) which serves as the legal road map for how the Members will manage and operate the business. The following represents a summary of key provisions Members of an LLC should address in an Operating Agreement:

1. Duties of Members to LLC. The Operating Agreement should identify what specific duties and responsibilities each Member has with respect to the ongoing operation of the LLC. If certain Members will provide full-time or part-time services to the LLC, the LLC should also consider entering into a separate services agreement with the active Member(s) who provides ongoing services to the LLC.

2. Initial and Future Capital Contributions to LLC. The Operating Agreement should address what initial capital contributions each Member must make to the LLC and whether the initial capital contributions will consist of cash, property or future services. The Operating Agreement should also identify whether the LLC can require some or all of its Members to make additional capital contributions to the LLC to fund operating shortfalls, capital expenditures, future business acquisitions or other future liquidity needs.

3. Income Tax Classification of LLC. The Operating Agreement should address whether the LLC will be treated as a partnership for federal and state income tax purposes or make an election to treat the LLC as either an S-Corporation or as a C-Corporation. The decision of whether to elect to treat the LLC as an S-Corporation or C-Corporation should be made in consultation with a tax accountant who can analyze the potential benefits of making an S-Corporation election or treating the LLC as a C-Corporation for income tax purposes.

4. Annual or Special Meetings of Members. The Operating Agreement should address whether the LLC will conduct regular or special meetings of the Members. The Operating Agreement should also address how the Members will record decisions made and business transacted at any annual or special meetings of the Members.

5. Buy-Sell Provisions. The Operating Agreement should address any buy-sell restrictions which govern the transfer and sale of membership interests (also often referred to as membership units) Members own in the LLC. If there are different classes of ownership, it may be preferable to memorialize the buy-sell restrictions and provisions in a separate restriction agreement which solely focuses on the buy-sell trigger events, valuation provisions and buy-out payment terms.

6. Drag-Along or Tag Along Rights. The Operating Agreement should address whether a majority or greater percentage of the Members will have the right to force all of the Members to vote in favor of a sale of the LLC’s membership interests or assets. Likewise, the Operating Agreement could include a provision which permits a minority group of Members to tag along with any sale of membership interests by a certain group of members to a third party.

7. Non-Compete and Related Restrictions. The Operating Agreement should identify whether any or all of the Members are subject to non-compete, non-piracy or similar restrictive covenants as they relate to the specific business conducted by the LLC. Non-compete, non-piracy and restrictive covenants can also be addressed within separate stand-alone agreements between the LLC and each Member.

8. Amendment or Restatement of Operating Agreement. The Operating Agreement should specify what type of approval process is needed to amend or restate the terms of the Operating Agreement. Special consideration should be given to whether less than all of the Members have the right to amend certain provisions in the Operating Agreement or restate the terms of the Operating Agreement in its entirety.

Please contact any member of our firm’s business law team to discuss a review of any existing Operating Agreement that your business may be part of or to discuss the process needed to prepare an Operating Agreement for your LLC.

Written By:
Law Firm of Conway, Olejniczak & Jerry, S.C.