Finances & Taxes
An operating agreement should explain how the LLC manages its finances and taxes. Financial provisions can address how financial records are kept, the members’ right to inspect financial records, financial reporting requirements, accounting methods & processes, bank account information, and whether the company will use professional financial advisors. The members may also choose to incorporate provisions that describe the LLC’s tax procedures. These provisions can include when and how distributions are made to pay member taxes, maintenance and adjustments of capital accounts for taxes, taxation of liquidating distributions, minimum gain chargebacks, nonrecourse deductions, and naming a partnership representative for tax matters. These technical tax provisions require consultation with a tax attorney or accountant to ensure the best outcomes for the company.
Transferring Membership Interests & Member Admission
An operating agreement should define procedures for transferring membership interests and admitting new members. Under the LLCA, there are generally restrictions on transferring all or part of a member’s ownership interest to other members, individuals, or entities, unless the other members vote to approve the transfer. With an operating agreement, members can elect to freely transfer their membership interests and define what rights and obligations follow from any transfers. Typically when members are able to transfer their membership interests, the recipient only receives the economic rights with the membership interest. In order to also receive voting rights, the recipient must be admitted to the LLC as a substitute member. That’s why it is important to define the processes for admitting a new member in the operating agreement. Such processes could include voting requirements as well as how the members formalize the admission through consent resolutions or a separate admission agreement.
Purchase & Sale of Membership Interests
An operating agreement should outline procedures for purchasing and selling membership interests. Purchases or sales of membership interests are typically either voluntary or involuntary transfers. Voluntary transfers are purchases or sales done under the member’s control. These transfers are what you would expect, a member desires to purchase or sell a membership interest to another member, individual, or entity. Involuntary transfers are purchases or sales that are done without the member’s will or control. Involuntary transfers, include events like death or disability, bankruptcy, divorce, termination or expulsion, or claims for dissolution or oppression. Regardless of whether a purchase or sale is a voluntary or involuntary transfer, the operating agreement should specify what needs to happen to effect the purchase or sale. These specifics can include any notice requirements to members, a process for exercising purchase options, the purchase price, the valuation of the membership interest, and any payment or closing terms.
An operating agreement should address what happens when the LLC is dissolved and the business is wound up. Typically the members will define conditions for dissolving the LLC, which can include, any time specified in the LLC’s articles of organization, by occurrence of certain events identified in the operating agreement, by member vote, or by judicial decree. The members should also outline the procedures for formally winding up the business. These procedures can include making a current accounting of all the LLC’s assets, liabilities, and operations, determining how the assets will be liquidated and distributed to the members, and discharging any outstanding liabilities.
Other Important Provisions
In addition to the considerations above, there are several other provisions the members should consider including in the operating agreement. These provisions include any general notice requirements, written acknowledgment of the filing of the articles of organization, the governing law for the agreement, any securities law disclaimers, a written attestation of review from legal counsel, and any specific definitions of terms used in the agreement.