No Rules for the Road; No Operating Agreement. LLC Mistake Number 8

You wouldn’t drive without knowing what a stop light, merge sign, or line stripes on the road meant, right? Those signals are what bring order out of chaos for those of us who travel the highways and byways of this nation—and many others. stoplightThose “Rules of the Road” are pretty universal, and mean the same thing to most drivers. They keep us moving in safety, stopping in synchronicity, and changing lanes predictably. By adhering to these rules, we “Arrive Alive” like the old safe-driving motto encouraged us to do.

Rules of the Road govern many activities of life. Polite society has rules, called “etiquette.” Every sport has its own rule book that controls how the game is played. Grammar is rules which allow us to communicate. Even physics has its own rules, most famously e=mc2.

So why this human fascination with rules? Because rules make for the famous “even playing field”; they ensure that folks who adhere to the rules are rewarded and folks who forget sportsmanlike conduct (remember Tonya Harding’s steel rule bookbaton and Nancy Kerrigan’s knee, anyone?) get punished.

Some rules are really complicated. Ever set a table for a formal dinner and worry about where to put all the spoons? Thank goodness for Emily Post! Ever had to work out the math on how to slingshot a probe to Europa around Venus twice and Mars once to get it to Jupiter on time? Me neither, but there are people who do this every day.

And that’s the point. When you drive regularly, launch a scientific probe occasionally, or play football every day, the rules get easier to understand.

Business, too, has its own rules. They are complex. They are confusing. And they are immutable. If you want to win at business, you follow the rules. Fortunately, there are people called lawyers who set up businesses every day and can help you understand the rules of business.

Setting up an LLC is deceptively simple. That simplicity is a clear advantage LLCs have over almost any other kind of business organization. Setting up an LLC can even be a “Do It Yourself” project. Go to the web site for the entity in your state that issues LLC certifications, fill out their paperwork on line, and get issued the LLC. Simple! You paid no legal fees and no fees to an online service.

llc-operating-agreementVoila’! You may think you have beaten the system, but have you really?
No! Your LLC also needs an agreement as to who owns the LLC (those folks are called “members”), what business it is in, how it will operate, how it will pay its bills, who is in charge, what happens if one of the members wants out of the business or wants to sell his interest to an outsider or transfer it as an inheritance. Typically, the name for this document is an Operating Agreement.

No Operating Agreement, No Bank Account. Stump set up his Main Street LLC by getting it on line from the state agency in his state that issues LLC certificates. Satisfied with himself and his progress, Stump went to open a bank account. The bank asked to see the Main Street LLC Operating Agreement. Stump did not have one and could not open a bank account in the name of the Main Street LLC until he had an Operating Agreement that authorized him to open that account. Without the Operating Agreement, no financial institution would bank on his business.

No Operating Agreement, No Lease. Alex negotiated a lease for a new store to sell smokeless water vapor cigarettes. His Vapor LLC will sign the lease and be liable for the liabilities of this new business. Alex set up his own LLC. The access_deniedprospective landlord wanted to know who had the authority to sign the lease for the LLC and asked to see the Operating Agreement of Vapor LLC. Alex did not have an Operating Agreement and could not get a lease until he had one. Without the Operating Agreement, Alex’s business was going up in flames.

Loan-DeniedNo Operating Agreement, No Loan. Harry wanted to get a loan for his business Harry’s Hot Dogs LLC. The bank would not give Harry the loan in the name of the LLC until Harry produced an Operating Agreement that showed that Harry had the legal power to sign loans on behalf of his LLC.

Bud and Allen Sue Each Other. Bud and Allen own several rental houses together. Bud puts up the money and Allen usually does most of the maintenance work, investing sweat equity. They formed LLCs for the properties, but then they had a falling out. Allen thought he was going to get 50% of the profits but Bud thought that Allen would only get 25% because Bud put up all the money and had to take up the slack when Allen didn’t or couldn’t perform. It got ugly. They had a big lawsuit over this situation which could have been avoided by having an Operating Agreement that dealt with these issues before they bought their first home together.

Does Your Operating Agreement Do the Job? See LLC mistake number 5, Who is in charge? as the best process for putting an Operating Agreement together where partners are involved.

To begin to create an Operating Agreement that does the job, you should consider these items and more:
1. What is the business of the LLC?
2. In what states or countries will it do business?
3. What is the best state or country to use to form the LLC?
4. Who will make decisions?
5. Will be it be a single member or multiple member LLC?
6. Will there be employees?
7. How will the members divide up income and expenses?
8. What happens if the Manager dies, quits or is removed?
9. When can a member sell his interests and to whom?
10. Who has the authority to sign contracts, checks, obtain loans, make loans, hire or
fire people or file or defend lawsuits?

These are just some of the issues. For a checklist of items that a strong Operating Agreement should cover, see our LLC questionnaire: https://wealthcounsellors.com/preparing-for-the-future-a-business-owner-s-checklist-2

Remember, the purpose of the Operating Agreement is to formalize the Rules of the Road for your company.

Just a three pager, please. People often ask us for a short form Operating Agreement because it seems less off-putting or threatening. And indeed, you can make an Operating Agreement as short as you like. But, the short form may cause problems in the future because it does not cover key issues or unanticipated disputes.

Each sentence in the longer form Operating Agreement is there because of some previous lawsuit. Unless you want to repeat the same lawsuit, go for an Operating Agreement that does the job. After all, you want your Rules of the Road to get you from here to there in one piece!

Does your Operating Agreement do what it needs to do for you? For a review of your Operating Agreement, call 571-633-0330 or email info@wealthcounsellors.com . By Roger McClure Edited by Ellen Paul. Copyright © 2015.

Roger McClure
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