Entrepreneurs organizing their new business entity often quickly discover that for all of its benefits – an LLC can be a complicated structure. Even a simple multi-owner operating agreement could easily be 50 pages long.
In the early days of LLC organizations, more than a few entrepreneurs never executed an operating agreement. As a result, several disputes erupted over verbal “promises” and whether they became an actual agreement of the parties. Today, this problem is best prevented by restricting amendments to the operating agreement to written amendments. Of course, today, operating agreements have grown to significant and complex documents.
With an LLC structure, there are few rules and many options. Although addressing these choices generates paper, clarity among the owners is critical.
An LLC operating agreement combines several concepts in one document that are recorded in multiple separate agreements when organizing a corporation.
Where the organization of a corporation by several shareholders will involve creating the articles of incorporation, the bylaws, a shareholders’ agreement, an information rights agreement and other ancillary documents, completing the organization of a limited liability company (after receiving the Certificate of Formation from the state) involves drafting and executing an operating agreement.
Articles of incorporation set forth the capital structure of a corporation.
The bylaws of a corporation document the officers of the corporation and their authority, the existence and powers of committees, and the notice requirements and procedures for meetings, as well as multiple other governance issues.
A shareholders’ agreement restricts the transfer of shares by the stockholders.
Each of the provisions of these various documents must be incorporated into the single operating agreement of an LLC, which can make for a very long document.
Also, the flexibility of the LLC structure generates many possibilities for decision making.
If a non-Manager managed structure is chosen, several important issues need to be resolved such as describing how decisions will be made and determining whether any authority will be delegated to a small group like a board of directors.
If the owners want to be truly passive in the management of the organization, they can simply appoint a single manager to make decisions, or they might limit the manager’s authority by providing a short list of issues that might require a vote of the members.
Perhaps the owners only want to vote on specific matters, such as obligating the LLC to a significant debt or raising new capital. The flexibility of an operating agreement structure allows for such a structure.
Finally, the founders and investors in a limited liability company often agree upon specific distribution parameters and these arrangements must be documented in the operating agreement.
In short, operating agreements are complicated because they not only cover a wide range of issues in a single document, but they also document the structure of distributions and decision making agreed upon by the founders and investors in a context where the issues are almost completely whatever the founders and investors dream up and agree.