If you are a single-member LLC or if your business partner is your spouse, this information might not apply. But if you are in business with another person, even a brother or sister-in-law, then a beefy Operating Agreement is a must have, at least eventually.
Operating Agreements are like By Laws for an LLC, and they protect the rights of the members and define the parameters in which the members can operate. In general, attorneys do an adequate job drafting this critical document, but there are some holes that the Watson CPA Group feels compelled to mention.
Death, Divorce, Incapacitation
Do you need one doctor? Two doctors? What is the triggering threshold? Traumatic brain injuries are no laughing matter of course, but you need to protect yourself if they occur. It is not just incapacity from a mental perspective either; your business might suffer if a member cannot physically perform the role either.
Accounting, Corporate Waste
In Colorado we are seeing a flood of marijuana investors. This is a cash business of course and all these minority investors are pouring their savings into a new pot farms. It is not a bad investment; first to market, stake your claim, build mega farms, control the pricing, etc. However, and this is a big however, it is still a cash business. Don’t you want a little assurance that the majority owner is not skimming the till?
Do you know how the IRS can determine your sales volume as a bar? They look at your purchases which is why most bars have to buy from a distributor. Determine the cost of goods purchased slap on a regional markup, and boom, you have sales regardless of what the cash deposits say. Same with divorces; we often look at lifestyle and spending to “back into” the income figures.
Another common example is when you are the minority shareholder or member. The majority elects to not pay distributions, basically starving you out. My partner would never do that? Really. Ok. But everyone else not living in fantasy land, an Operating Agreement can protect from this situation.
Arbitration is like mini-court and the rules of discovery and evidence are usually more relaxed. They can be expensive since you are paying for your attorney plus the arbiter who is usually a retired judge or attorney. However, they can also be efficient.
Regardless of mediation, arbitration or trial, make sure your Operating Agreement has expeditious dispute resolution provisions, and incentives for all parties to be efficient and bargain in good faith.
As a side note, if the value cannot easily be derived from a formula, then the out-member and the remaining members each pick a business valuation expert. Then those two experts pick a third as a neutral.
As we’ve said in the past, just because you are working with an attorney or an accountant doesn’t mean you are working with a smart person. The Watson CPA Group can act as a consultant with your attorney when drafting these documents.
Taxpayer's Comprehensive Guide to LLCs and S Corps : 2019 Edition