Why Is an LLC Operating Agreement So Important in California?

Why Is an LLC Operating Agreement So Important in California?

What is the purpose behind an LLC operating agreement and why is this such an important document in an LLC in San Diego and Southern California? In these days of downloading forms from a website and rushing into business most LLCs miss one of the most important issues in the process of forming a business – the operating agreement.

If you are a one-person company you will be making all of the decisions and an operating agreement may not seem that important to you. However, if there is going to be more than one owner or “member” in your LLC the operating agreement is an essential document that deserves your attention. What is the operating agreement? The operating is a contract between the members of the LLC which establishes the responsibilities, voting rights and other duties of each member of the LLC, as well as how business decisions and operations will be undertaken.

What is the role and responsibility of each member? What percentage of ownership does each member carry and what duties and voting rights are associated with that membership?

How will profits be distributed between the parties? How often will the company hold meetings and how will they be conducted? What happens if there is a substantial life event (often referred to as a “trigger”) for one of the members such as death, incapacitation, divorce or personal bankruptcy? What happens if a member is no longer able to sustain their financial commitments to the company or exercise their duties?

Do you want the ex-spouse of a fellow member to take half of their ownership (and voting rights) during the divorce? Suddenly you have a new business partner. Now what? Consider the unexpected death of a member. Without the right protections their ownership interest (and control) will pass to their designated heir.

There are almost 100 crucial clauses to be decided upon. Some will be a “do you want THIS or That?” Others will be “do we include this or not?”

Perhaps you should consider the valuation of a member’s interest if a triggering event occurs. Who has the right to buy-out their interest and at what price? If there are multiple members with varying percentages of ownership, should the exiting member’s interest be divided proportionately according to the remaining member’s percentage of ownership?

It may surprise you to learn that California has a strong body of law that protects minority interests in normal operating decisions and in any subsequent dispute. Do you really want California’s “default legislation” to determine what happens within your own company?

Finally, consider why you have a corporate entity in the first place. Your LLC is an entity which separates you, personally, and all of your personal assets and debts from the corporate entity of an LLC. This is known as the corporate veil. This crucial separation of the members personally from the company prevents creditors of the company from pursuing the owner/members of the company personally for debts or liability of the LLC. You want to protect your personal assets and all you’ve worked so hard to build. The operating agreement actually establishes that corporate veil and additional protections which protect the individual interests of each member, as well as the interests of the members as a whole.

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