A Limited Liability Company (LLC) falls somewhere between a general partnership and a more formal corporation. It provides protection for individual members and offers significant tax incentives. Thus, LLCs are a common way to structure small businesses.
An LLC needs a strong operating agreement drafted with a specific understanding of small business needs. This contractual foundation is especially important for budding entrepreneurs. A well-drafted contract can mitigate some of the issues that new companies face.
An operating agreement is used by members or managers of an LLC. The operating agreement ensures that all of the rules are followed and that everyone understands how the company will proceed. An operating agreement for a limited liability company is, in essence, a contract. Except for a few statutory and modifiable rules, the drafter gets to design the majority of the rules that the entire company is to follow and abide.
One of the most important sections in the operating agreement is the capital contribution section. A capital contribution section usually addresses what happens if members fail to contribute their portion of the initial start-up capital. This section also addresses what happens if a member wants to withdraw their capital contributions, ownership of the assets in the company and whether or not the company can require additional contributions.
Many times, members want the ability to pull out money from their capital contributions. This can become a problem, where there is a large group of people pooling funds for a common purpose. If a member withdraws money at any time, it makes it difficult for the company’s management to make decisions such as purchasing real property, assets, taking on employees, etc. Management must then consider if the company can make such a significant financial commitment if members have the ability to constantly move funds out of the company. 5
The capital contribution section is also important if the Company owes money to a judgment creditor. It is possible that a charging order issues against their membership distributions. A clever manager of the Company might say that the member can pull out their capital contributions in the form of distribution. However in this case, if the LLC has protection in the operating agreement which explicitly states that members or managers do not have the authority to pull that money, the judgment debtor can find themselves in a better position.
An operating agreement should require that all assets acquired by the company be in the company name. This is to ensure that there is no dispute over the ownership of an asset, especially if there are many assets collected by the company and multiple members. This is usually done by either acquiring title in the name of the LLC or transferring title to the LLC shortly after purchase. Other times, an asset might be part of the capital contribution, if so, it is important to have clear ownership lines drawn.
Finally, the additional capital contribution clause is one that the drafter should make sure not to overlook. It is crucial for the drafter to understand each member’s financial position and ability to contribute additional funds should the need arise. If the drafter decides that the additional contribution clause is going to allow members or managers to request more contributions there should be a limit on the total capital contribution amount that can be requested in a certain period of time.
If you are creating an LLC, or have created a LLC, but do not have a written operating agreement, contact your business attorney and get one!
The information presented is not intended to be, and does not constitute, “legal advice.” Because each situation varies, and only brief summary information is provided here, you should not use this information as a basis for action unless you have independently verified with your own counsel that it applies to your particular situation.
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