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Does Your Family-Run LLC Need an Operating Agreement?
In brief, “Yes.” Even a family-run limited liability company (“LLC”) needs a well-drafted and solid operating agreement. One of the most common mistakes made by family-run businesses is assuming that normal business practices are “not necessary because we are family.” The truth is quite the opposite. The old saying is that “good fences make good neighbors.” A similar rule applies to family-run business; good operating agreements or corporate bylaws make good family businesses. Feelings cloud judgment and reason; a successful business runs on the latter. A good San Diego corporate lawyer can help. This article discusses why an operating agreement is essential for a family-run LLC. These concepts also apply to any family-run business regardless of the corporate form used.
San Diego Business Law: What is an LLC Operating Agreement?
Many are familiar with corporate bylaws; an operating agreement is the equivalent of bylaws except an operating agreement is the foundation set of operating rules for an LLC. A limited liability company is a type of corporate form that is similar to the more-familiar corporation. An LLC provides many of the same advantages, but allows for more flexibility with respect to ownership and control interests as opposed to rights to profit and economic distributions. An LLC is a good business form for a family business because all the family members might be invested with the same share of profit distributions — principle of equality — while control and ownership might be limited to certain members of the family — recognizing that some family members might be better at business than others. In general, the “equality principle” has to be subordinated to the “who-is-best-suited-to-run-the-business” principle. An LLC’s operating agreement defines and sets out these types of distinctions within the parameters set out by the California Corporations Code. See Cal. Corp. Code, §§ 17701.01 et seq.
In addition to delineating capital, profit, and ownership interests, the operating agreement defines the method and means of control. Under California law, an LLC can be a single member LLC, a member managed LLC or a manager-managed LLC. The latter two are often more relevant to a family-run business. If the family chooses to manage the LLC, such is set out in the operating agreement. Conversely, if the family has hired — or plans to hire — a manager to run the business, then that is set out in the operating agreement as well.
The operating agreement also sets out how profits are distributed and how new owners/members can be added. This is important for a family business since new members of the family are often added through birth, adoption, and marriage. Just as importantly, the operating agreement sets out the rules when members of the family are removed, such as via divorce proceedings or death.
San Diego Business Law: Reasons an Operating Agreement is Essential for Family-Run LLCs
As can be seen, an LLC operating agreement is essential. This is even more true for a family-run business where feelings, loyalty, equal treatment and other emotions get wrapped up in business decisions. The goals are twofold – avoiding angry disagreements and family strife and ensuring that any family strife does not bring the business to a halt and prevent the business from operating successfully. The operating agreement is essential to both goals. The agreement should set out the basic expectations with respect to the following issues:
- Control of business decisions — who has involvement and who has the most “say”
- Breaking deadlocks with respect to business decisions
- Profit sharing and taking money “out” of the business
- Adding/removing owners
- Adding/removing owners who are not family members
- How family members/owners may “cash out” — buy/sell provisions
- Valuation methodologies
- Succession planning and inheritance issues
- And more
Call San Diego Corporate Law Today
For more information, call experienced business attorney Michael Leonard, Esq., of San Diego Corporate Law. Mr. Leonard can draft your operating and ownership agreements, provide legal advice and help set up your San Diego LLC (or corporation), and/or assist with any other contracts you might need for your family business. Call Mr. Leonard at (858) 483-9200 or contact him via email.
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