If you are forming an LLC with your bestie—and you want your bestie to stay your bestie—you need an operating agreement. People tend to think of legal agreements as an indication that they don’t trust their business partners. That really isn’t the point of an operating agreement. You probably think you’re on the same page. How do you know for sure? An operating agreement. How are you going to handle differences in opinion later on? You create strategies to break ties…in your operating agreement. How do you protect yourself from default LLC provisions that run counter to the way you want your business to operate? Again, an operating agreement.
An LLC (or Limited Liablity Company) is a very popular business entity because it is easy to form and administer. It provides its members (LLC terminology for “owners”) protection against personal liability but without the formalities associated with a corporation. An LLC, however, is governed by state laws. That means an LLC in Florida may not have the same rules as an LLC formed in Mississippi. What that also means is that if your LLC does not have an operating agreement, your LLC is governed by the default rules of your state’s LLC statutes. In addition, it means that if you don’t provide certain provisions in your operating agreement, those provisions are provided by the state’s LLC statutes. And, those may not be provisions you want.
Did you know that when a member dissociates from (LLC terminology for “quits”) an LLC in Florida, he is no longer bound by the fiduciary duties of loyalty and care and he is no longer restricted from operating a competing business BUT he still has rights to receive distributions from the LLC? That means he can open a business that competes with your LLC and still receive distributions from your LLC. Do you really want that? Probably not. You can fix that in your operating agreement.
Did you know that if you dissociate from an LLC in Florida, the dissociation does not trigger an immediate distribution or return of capital? That means if you decide to quit, you may be entitled to regularly scheduled distributions along with the other members but you may not be entitled to your share of the profits in a lump sum or any return of the capital you invested in the LLC. This can also be fixed in your LLC’s operating agreement.
So, as you can see, an operating agreement can protect you from default LLC provisions that aren’t desirable to you. But, let’s get back to your relationship with your best friend. How does an operating agreement protect that friendship?
You may have been planning this business endeavor for a very long time. You probably think you and your bestie are in complete agreement over how to run the business, how you are going to make business decisions, and that you are going to keep the business for two years and then sell it and take a trip to Jamaica. What you may find out while discussing the operating agreement with your attorney, is that your bestie doesn’t want to sell the business. He wants to keep it and pass it down to his children and grandchildren. You may also find out that the sweat equity you are providing to the LLC –that sweat equity that you think is worth $100K –is not valued as highly by your friend. What if he thinks your sweat equity is only worth $20K? Figuring this out at the beginning rather than two years down the line is really important. The earlier you discover these differences in vision, the earlier you and your co-founder can figure out how to compromise to achieve goals that make both of you happy.
Drafting an operating agreement also makes you think about the difficult issues. It makes you come up with a plan for breaking ties in the inevitable situation where you are at a deadlock. It also makes you think about what happens if one of you leaves on bad terms or, heaven forbid, you feel the need to force your friend out of the business due to his bad behavior. It makes you think about what happens if one of you dies or is incapacitated. Are these fun conversations? Of course not. But, if you think these things through before they actually happen, the blow will be less severe when and if they do.
I hope you now understand the importance of a good operating agreement for your LLC.
Want your bestie to stay your bestie? I’m here to help.