The creation of the limited liability company (LLC) as a business entity was transformative for small businesses.
It took the best of the C corporation and partnership models and also perfected the intentions behind the S corporation.
However, an LLC without an operating agreement is but a shell.
To truly realize the potential that an LLC business model provides, a well-drafted Texas LLC operating agreement is essential.
What Is an LLC Operating Agreement?
A Texas LLC operating agreement is a written document that sets out the rights and obligations of the members of an LLC for its operation, governance, and distribution of economic benefits.
The nature and attraction of an operating agreement are that you can basically design it as you like. There are model operating agreements with standard terms that can be customized to fit your business.
On the other hand, more seasoned business persons sometimes form an LLC but adopt corporate bylaws as the operating agreement because they are more comfortable with “corporate” language.
Operating agreements could also be tailored to mirror a general partnership agreement. Nevertheless, in whatever form, an operating agreement is a binding contract between its members, and courts will generally honor it.
Why Do I Need an Operating Agreement?
A well-written operating agreement will reduce or largely eliminate member disputes. To that end, providing members with a clear procedure of how to handle business matters is an operating agreement’s power.
As a result, it increases operational efficiency both for internal affairs and external activities.
When considering Texas LLC operating agreement requirements, experience shows there are several common flashpoints between LLC members that a well-drafted version can help resolve.
We will discuss each of those flashpoints below.
The overwhelming majority of LLCs are small businesses started by individuals who know each other well.
In the early days of an enterprise’s existence, everyone typically assumes they will get along and that the business vision for the LLC is shared and harmonious. But inevitably, business visions and operational opinions change.
Absent an operating agreement, changes of opinion can cause major trouble in the form of operational paralysis where members cannot agree on how to proceed — or they begin to exert undue influence over each other. A well-crafted operating agreement can help avoid such crises.
Here are a few examples of how it can work to maintain order:
- The LLC can appoint a manager who will have control over the day-to-day affairs of the LLC, only requiring member voting on select matters (e.g., taking out a business loan, buying real property, etc.).
- Certain business decisions can require different voting thresholds (e.g., three-quarters vote to approve any purchase over $10,000.00, or a simple majority vote to purchase new company software, etc.).
- Voting interests don’t always have to match economic interests. An operating agreement can provide for an even allocation of the economic interests but then have a different allocation of voting rights.
The point is to structure the management powers and voting rights to avoid paralysis or leveraging and embody them in an operating agreement.
Member Admissions and Dissociations
Because LLCs are small businesses, outlining how members are admitted and how they are dissociated can prevent major disputes. An operating agreement can offer several possible methods for both of these events.
- Admission of new members should require a specific vote and set forth any required capital contribution.
- A voluntary sale or transfer of an existing member’s ownership interest should provide other existing members an opportunity to purchase that offered portion before it is sold or transferred (i.e., a right of first refusal – “ROFR”).
- Involuntary membership interest transfers (e.g., death, divorce, etc.) should also provide for an existing member ROFR.
- In the event of a buy-out (i.e., forcing out a member) the operating agreement could provide for the valuation and purchase method of the membership interest.
- When a member wants to leave an LLC, he can force the LLC or its remaining members to buy their interest under the same valuation and purchase provisions.
When any of these events go unaddressed in a proper operating agreement, it can significantly disrupt LLC operations.
Therefore, careful control of admissions and dissociations of members is critical to an LLC’s functionality and efficiency.
Conflicts of Interest
Often an LLC member’s relationship with another business can come into conflict with the LLC. For instance, an LLC member’s secondary business can fulfill a commercial need for the LLC but also enrich that member.
Or, the LLC’s business may directly compete with a member’s secondary business venture. However, all members can peacefully coexist if the operating agreement addresses these issues properly.
For example, the operating agreement could either require dissociation from the competing business or allow competition under clearly outlined conditions.
What if I Do Not Get an Operating Agreement?
If you do not get an operating agreement, your LLC will be governed by the Texas Limited Liability Act. However, these statutes are skeletal in substance and clumsy in their application.
While better than nothing, try to avoid relying on the statutes if at all possible. Unsurprisingly, a lack of guidance by statute usually results in litigation.
Therefore, do not put yourself in a position where important LLC business matters are governed by a generic statute that fails to take into account your company’s specific needs.
A well-crafted LLC operating agreement in Texas that takes into account the personalities and visions of its members can keep it from operational paralysis, disruption, and litigation.
How a Texas Business Law Attorney Can Help
Our business lawyers have the experience to craft a Texas LLC operating agreement that embodies all the best aspects of model agreements but is also uniquely tailored to you and your business partners’ needs.