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A limited liability company (LLC) is designed to protect the personal assets of business owners with minimal paperwork and offers more flexible management. Simply put, an LLC is a separate business entity from the owner that can protect the members of the LLC from legal liability. Even though an LLC aims to protect its members (owners), without a clear Operating Agreement, the LLC might not be as protected as they would hope.
When forming an LLC in Delaware, you will need to file paperwork called the Certificate of Formation. While you are completing this form, you can create an LLC Operating Agreement.
Delaware is one of only a few states that require an Operating Agreement. But even if it weren’t legally required, an Operating Agreement is a vital document for an LLC. Operating Agreements detail the rights and responsibilities of LLC members and can help protect every member from personal liability.
In this guide, we’ll cover the basics of an Operating Agreement in Delaware and how to draft this important document.
An Operating Agreement is a document used to protect the owners’ assets from any action of the LLC. In short, an Operating Agreement helps to secure your personal assets when you are part of an LLC. In Delaware, an LLC can create an Operating Agreement; however, it is not required. If an LLC creates an Operating Agreement, you should be sure to get written consent on the document you created from all the LLC members.
One of the reasons that Operating Agreements are good to have is that they allow you to avoid some of the default rules in Delaware. With an Operating Agreement, your LLC can avoid some of the default guidelines and rules set by the state. In addition, an Operating Agreement describes the legal and financial details needed to secure funding from lenders and investors.
As we touched on briefly, having an Operating Agreement in Delaware is legally required. But in addition to that, it can be a real asset to your LLC and can help protect you in the future.
The U.S. Small Business Administration (SBA) recommends that every LLC have an Operating Agreement because of the added protections that it offers. An Operating Agreement should be signed by every member of the LLC and is an official contract binding every individual to its terms.
Even for a single-member LLC, an Operating Agreement helps establish your business as a separate entity from yourself in the eyes of a court of law.
Additional benefits of having a Delaware LLC Operating Agreement include:
An Operating Agreement is quite possibly the most important document you will create when starting your LLC, which is why it’s incredibly important to have an inclusive and direct Operating Agreement. Thankfully, ZenBusiness provides a template to help develop your Operating Agreement.
This document details the internal affairs in your LLC and, because of this, should be kept with your other business records and be accessible to the members of your LLC. If you’re unsure where to start in terms of drafting it, you might want to check out the Delaware Limited Liability Company Act, which can provide some helpful hints on items you’ll want to touch on, such as duties of members.
In short, you may want to include this information in an Operating Agreement:
An Operating Agreement is a powerful tool to protect your LLC and should not be overlooked. Luckily, you can reference the ZenBusiness Operating Agreement template to get you started.
There are some items that every Delaware LLC Operating Agreement might want to consider including:
Ensure the name of the company in your Operating Agreement is the same as it’s written on your Delaware Certificate of Organization when you register your company with the state.
Spell your name the same way — don’t use any abbreviations or alternate spellings.
List all owners of your LLC in this section. In addition to the names of the owners, you should also determine their ownership percentage and include this figure. Their ownership percentage is often determined by comparing the amount they invested in the LLC to the total amount of money invested by all members. The amount invested can also be referred to as their capital contributions.
In certain cases, you might determine ownership percentages in other ways, including how involved an individual is in managing the company.
In terms of management of the company, there are two types of management to consider for your LLC: member-managed and manager-managed.
If you don’t specify your management structure in Delaware, you’ll default to a member-managed LLC. Determine which form of management works best for your business.
The key differences between the two management structures come down to the relationship between ownership and management. A member-managed LLC is led by its owners, while a manager-managed LLC creates a managerial role separate from ownership. This manager (or managers) has the authority to make day-to-day decisions regarding the business, and the owners aren’t typically involved in regular operations. The managers can be members of the LLC, someone(s) hired from outside the company, or both.
In this section, you’ll delineate all of the expectations you have for your LLC’s members and managers.
All members, even those least involved in the company, will likely have certain duties. This might mean voting on various issues related to the LLC. Other members might have more substantial duties and powers related to operations.
One obligation that members usually have is voting. What decisions require a member to vote? Does a vote need a majority to win, or does it need to be unanimous? Is voting power distributed equally among members?
Often an LLC will divide voting power up according to ownership. So, a member who owns three-quarters of the LLC will have three votes compared to one vote of a member who owns one-quarter of the LLC. But this voting structure is not required. You and the other members get to decide how much each member’s vote weighs and put it in the Operating Agreement.
Your Operating Agreement determines how you distribute your profits among your members.
As an LLC, you have some flexibility with how you can distribute profits. You just need to be clear in advance about who receives what at the end of each year. The distribution of profits doesn’t necessarily need to be doled out based on ownership percentages.
You’ll also need to cover who is responsible for distributing the profits, by what method, and how often.
As an LLC, there are no legal requirements to schedule and host member meetings.
That said, it’s still helpful for your company to host meetings regularly. So, your Operating Agreement should determine when, where, and how they are organized.
By laying this out in advance, you can determine how frequently you meet and what will be discussed. It’s often advantageous for your members to meet regarding your LLC’s tax requirements.
Your Operating Agreement will lay out what happens when members leave or join the company.
You might choose to welcome new members, or others might choose to step away from the business.
How much must a new member invest to come on board? What happens to a member’s ownership percentage when they leave? These are questions that your Operating Agreement might answer.
Also, as members depart, your agreement can determine who has first dibs on their portion of the company. Can a departing member offer their percentage of the LLC to anyone? Must they first offer to sell to the remaining members?
If an LLC member dies or retires, their ownership percentage must be transferred. The Operating Agreement needs to specify whether they are permitted to leave it to anyone they choose or whether their portion of the business needs to be transferred to existing members.
It’s one thing for a member to choose to leave your company, but it’s another matter entirely when a group of members chooses to dissolve the LLC.
Your Operating Agreement must lay out the terms for dissolving the company. Is a majority or unanimous vote needed?
Your document should also determine what happens to any remaining assets when the LLC is dissolved. Often, there are a lot of loose ends when you shut down a company. You can’t just walk away from it without making sure everything is wrapped up. There could be legal ramifications if you don’t handle everything the right way.
Your members can modify any terms of your Delaware LLC Operating Agreement at any point, but you need to determine how these modifications are made.
Your members will vote to add, remove, or tweak terms included in your Operating Agreement. How many member votes are required to make changes to the agreement? Do you need a unanimous vote to update your Operating Agreement? Or will a supermajority or just a majority get the changes made?
Whichever format you go with for modifying your Operating Agreement, just make sure it’s spelled out in the document.
A single-member LLC has just one person, and thus has 100% ownership of the business. It might seem like some of the points above (such as the details about voting in a multi-member LLC) are irrelevant in this case.
However, to help protect yourself legally, it’s wise to include a single-member LLC statute. This specifies that you are the exclusive owner and have full authority to make all of the LLC business decisions.
A severability provision is a clause seen in nearly all types of contracts. It specifies that if one part of the contract is invalid, it doesn’t invalidate the entire agreement. Thus, the Operating Agreement won’t be meaningless because of a single mistake.
When you created your business, you likely did not imagine all of the steps that come with protecting everything you’re passionate about. Creating a separate legal entity with an LLC is a great first step to protect your personal assets.
Drafting an Operating Agreement puts a plan in place and also allows your company to open a business bank account and work with investors. All in all, drafting an Operating Agreement in Delaware is a critical step in forming a successful LLC.
There are many reasons you may need to update your LLC’s Operating Agreement. Luckily, you can change your Operating Agreement at any time if you follow the correct procedures. All members will need to approve amendments to the Operating Agreement and you’ll want written notice of any revisions.
You should update or revise your Operating Agreement when:
It’s a good idea to get into the habit of reviewing your Operating Agreement when you are reviewing other key items that might have changed over the course of the year like the address to your place of business, your registered agent and/or registered office. This can be around the same time you file your annual report.
Yes, Delaware is one of the few states that legally require an Operating Agreement.
You can get a template from ZenBusiness to help create an Operating Agreement.
Just like any Delaware LLC, a single-member LLC is legally required to have an Operating Agreement.
You do not need to file your Operating Agreement with any government agency. Instead, it’s recommended that you store your Operating Agreement with other important business records.
Although you can technically write your own Operating Agreement, it’s a good idea to use a template so that you do not miss any crucial information. You may also want to consult a legal professional to review the document before having members sign.
You ‘re not required to use a lawyer for an Operating Agreement in Delaware; however, running an Operating Agreement by a lawyer or industry professionals can help you develop a comprehensive Operating Agreement.
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