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, commonly referred to as an “LLC”. Like a corporation that is owned by its shareholders, an LLC is owned by its “Members”. Members of an LLC may, but are not required to, take an active role in the management and operation of the LLC. However, absent an agreement describing the rights of the Members of the LLC, each Member of the LLC will have very broad authority to act on behalf of the LLC, or to sell his ownership interest in the LLC, commonly referred to as a “Membership Interest”. This broad authority can have undesirable and unintended consequences, such as one Member taking actions other Members do not agree with, or one Member selling his Membership interest to a third party. To limit this broad authority and to, Members of an LLC enter into an “Operating Agreement”. Operating Agreements can cover any topic, but commonly they cover one or both of just two topics: management of the LLC and restrictions on transfers of Membership Interests. Requiring the Members to agree how the LLC will be managed, and how Membership interests can be bought and sold, can go a long way to avoiding disputes in the future. Without an Operating Agreement, one Member of the LLC might be able to take actions on behalf of the LLC that other Members do not agree with, or could sell his Membership Interest to a perhaps unknown or undesirable third party.
Management A. Deciding who will be responsible for management of an LLC is a key consideration in any business. An LLC can be “Member Managed” or it can be “Manager Managed”. In a Member Managed LLC, the members of the LLC are responsible for the management and operation of the LLC. In a Manager Managed LLC, the members appoint one or more “Managers” who are responsible for the management and operation of the LLC. The Managers may, but are not required to be, members of the LLC. Opting for a Manager Managed LLC is particularly advantageous if one or more Members of the LLC do not plan to be involved in the management of the LLC, or if a single Member will typically be responsible for handling the active operations of the LLC.
Accordingly, you will want to ask yourself the following questions:
there is a range of restrictions on the transfers of Membership Interests of the company which the Members may want to consider. Selling or transferring Membership Interests to people who are not already Members of the LLC Approving any merger or sale of all or substantially all of the assets of the LLC. 8. warrants. Investing in another company. Selling or transferring Membership Interests to an existing Member. or will it be Manager Managed? o Do you anticipate that just one or two of the Members will take an active role in operating the business? o Will you have a large number of Members. Giving a security interest on any asset of the LLC. the Operating Agreement can stipulate that a “simple” majority vote (51%) of the Members is required to authorize the company to borrow or spend amounts up to $10. The common items are: 1. 66% or 75% of the Members). Entering into any transaction out of the ordinary course of business. or anything else convertible into Membership Interests. Selling any asset of the LLC with a value in excess of a stated amount. Mortgaging any real estate owned by the LLC. Basically. 13. do you want to have more than one Manager? Who will the Manager or Managers be? • B. For example. Amending the Certificate of Organization. 2 . or Guaranteeing the obligations of another person or entity. Restrictions on the Transfer of Membership Interests A. 10. 11. 6. 3.• Will the LLC be Member Managed. 12. Regardless of whether the LLC is managed by Managers or by its Members. 4. 9. Amending the Operating Agreement. Borrowing money in excess of a stated amount. but that a unanimous vote.000. so that it might be difficult to get all of the Members together to manage the LLC? If it the LLC will be Manager Managed. 5.000. The range runs from prohibiting any transfer. 7. 2. is required to authorize any amount over $10. The Operating Agreement can be structured so that any of these items can only be taken upon the affirmative vote of a certain number of Members. or a “supermajority” vote (typically. The list of these things can be short or long and can include almost anything. Issuing options. you will want to consider whether there are some things that the Members want to prevent the Managers or the Members from doing without the approval of all or a certain percentage of the Members.
2. or are permitted only on a very limited basis. B. The next problem is how to value the Membership Interests that are being sold. Commonly. or at a price that is set in the Operating Agreement. they should consider that this makes it harder for a Member to get his or her value out of the shares. There are a variety of ways to value Membership Interests. To the extent the Members decide to limit the transfer of Membership Interests. they can be sold to the third party. This obviously affects the value of those Membership Interests. On the other hand. 3. or to a trust which has been established for the benefit of the Member and/or his or her spouse or children. either at a price equal to the offered price. 1. This is because it may be very difficult to find someone who wants to purchase a minority interest in a company. this sort of mandatory repurchase provision in an Operating Agreement is a way for the remaining Members to prevent the shares from falling to the hands of a potentially undesirable shareholder. Members should consider whether there should be provisions in the agreement to permit the Member who wants to sell his or her shares to sell them to the LLC. who becomes permanently disabled. Also common are provisions that require the LLC and/or the other Members to buy the Membership Interests of a Member who dies. Members who find a purchaser for their Membership Interests are required by their Operating Agreement to offer their Membership Interests first to the LLC. When the shares of a LLC are basically illiquid. or other Members. Then. as in generally the case when dealing with small. or an average of the last 3 fiscal years. and then to the other Members. or who leaves the employ of the LLC. if the Membership Interests are not purchased by either of those groups. the relationships between the Members. it prevents the sale of Membership Interests to undesirable third parties that the Members may not want to be in business with.to permitting transfers only to spouses or children. or anything less than 100% of a company. using either the earnings of the most recently completed fiscal year. closely held companies. to permitting transfers only upon the death of a Member. to permitting sales to anyone. Also. Commonly used methods are: • taking a multiple of the LLC’s earnings. 3 . • having the Company or the Membership Interests appraised. depending on the nature of the business of the company. or • agreeing each year on a value for the shares. this may be the only way for the estate of a Member or for a retired employee to obtain any value from his or her shares of stock. The valuation provisions of the Operating Agreement can be quite simple or can be quite complicated. without requiring Member consent. and how much the Members wish to spend on it. If transfers are not permitted.
pursuant to the terms of a promissory note. Furthermore. the Operating Agreement can require that the payment be made in different ways. 4 . usually in an agreed upon form attached to the Operating Agreement. Finally.The Operating Agreement can also require that payment for the Membership Interests be made in cash. depending on the event triggering the sale. so that the company can be sure it has sufficient funds to purchase the shares. buyout and mandatory repurchase provisions that are triggered by the death of a Member are often funded by life insurance policies. or can allow the payment to be paid over a longer period of time.