Monday, August 31, 2009

Limited Liability Companies - Get the Operating Agreement

Nothing from Why You Need Professional Advice and an Operating Agreement for Your LLC differs greatly from what I advise people wnating to start a limited liability company, so pay attention.

Absent an operating agreement, many critical issues will be determined by statute. Let’s say, hypothetically, that a business person establishes an LLC, coming up with the business plan and strategy and contributing the capital to start the business. Further assume that she decides that a trusted assistant should have a small equity interest in the business, both as a reward and an incentive to perform. Thus, the founder files the LLC paperwork listing herself and the assistant as the two members.
In Indiana . the same surprise awaits the unwary creator of a LLC:
The founder may be surprised to find at a later date that, because there is no written operating agreement, she and the assistant are, by Georgia statute, entitled to equal votes in managing the business. O.C.G.A. § 14-11-308(a)(1). In addition, the founder and the assistant are entitled to equal profit distributions. O.C.G.A. § 14-11-403. The founder will also find, as a consequence, that the assistant has the legal right effectively to block anything the founder wants to do with the business.
Which is why I suggested last week to a potential client that an LLC would not do what he wanted to do - maintain control.

I like the sense of hope given in this paragraph but I would not want to rely on anyone's altruism in a business situation.  As Cindy Lauper once sang, money changes everything.

It may be possible, if the assistant is a reasonable person, to clean this up at a later date by adopting an operating agreement that makes the assistant the minority equity holder and that allocates voting rights and profit distributions as was originally intended. However, if there has been a falling out between the two members, or if they simply honestly disagree on what their respective rights should be, it can lead to a very difficult dispute.
Pay attention to this paragraph:
Of course, if the founder had consulted a lawyer in establishing the LLC, this scenario would have been avoided. The issues would have been addressed in an operating agreement, making the founder the manager, establishing the percentages for profit distributions, and dealing with many other issues.

I spoke wiht another person this past week who is looking to litigate a business set up problem.  When I asked if the business had been incorporated, I was told that the other people decided a lawyer was too costly.  Thiose same people will now be paying more to defend a lawsuit with a likelihood of paying damages.  So much for saving money on lawyers.