What Belongs in an LLC Operating Agreement? (Part 3 of 3)

This is part three of a three-part series on what does and doesn’t belong in a written LLC operating agreement. Part one can be found here and part two can be found here.

In parts one and two we discussed ten issues that should be addressed in your LLC operating agreement.  Here are some that do not belong.

Terms that usually don’t belong:

Employment provisions. If an LLC member or manager is also going to be an employee of the company, that is better handled in a separate employment agreement. Note that there can be tax implications on LLC owners drawing a salary or guaranteed compensation from the company, so be sure to check with your CPA before finalizing those types of details.

Detailed descriptions of the company’s business. Most LLC operating agreements contain a “purpose” clause, meaning a statement of what the company’s purpose is. I think that’s fine, but caution against being overly specific or restrictive when describing an LLC’s business in an operating agreement. First of all, the company’s business might change over time, and it seems like nobody ever remembers to amend the operating agreement. Second, if you paint yourself into a corner by including an unnecessarily detailed description of the LLC’s activities, you run the risk of being in breach of the agreement if the company pivots to a different direction. I think the risk of that is low, but when an internal dispute arises, vindictive individuals look for any weapons they can use against the other members or the company itself. Unless there’s a legitimate reason to be specific about the company’s purpose, why risk it? I also note this type of risk can be mitigated by including a “catch-all” purpose clause, such as adding “and any other business activity that is legal for an LLC to conduct under applicable law” or something to the effect to the end of your purpose statement.

Provisions unrelated to your unique situation. From time to time I run across individuals that have downloaded a cookie-cutter LLC operating agreement from the Internet without any modification. Adopting a written operating agreement that isn’t customized for your business is probably worse than not having an operating agreement at all. LLCs are often used as special purpose vehicles (SPVs) with a narrowly defined purpose, such as asset protection planning, real estate, or a joint venture. Including inapplicable provisions in your operating agreement will create confusion if there is ever a dispute. If you’re creating an LLC to run a software business, using an operating agreement designed to hold a vacation home won’t make any sense.

Provisions that neither you nor your lawyer can explain or understand. I see this often and admit I have even been guilty of it myself. Some operating agreement language, particularly relating to LLC capital accounts and the tax code, can be nearly impossible for anyone other than a tax expert to understand. Sometimes there’s no better way to capture exactly what is intended in a legal agreement than to use complicated language. On the other hand, if you can’t understand it, your lawyer can’t explain it in a way you understand it, and your CPA can’t explain it in a way you understand it, it probably doesn’t belong in your operating agreement.

I hope that this series of articles has helped to demystify some of the confusion around LLC operating agreements. If you have questions about LLC operating agreements or other business documents, I hope you’ll contact me. I’d love to hear from you!

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