An Operating Agreement is a binding agreement between business partners who jointly operate a Limited Liability Company (LLC) in California.

If you are operating a California LLC, you should have a written Operating Agreement to set out your business structure. Most executives agree that they want to have more certainty in their business.

Therefore, an operating agreement should, at minimum, address the following:

  • The percentage ownership of the Company among its members
  • Voting rights or non-voting membership
  • Powers, duties, and obligations of each member
  • Valuation of the business and buy-sell procedures
  • Management of the Company and compensation for member-managers
  • Distribution of profits and losses
  • Accounting procedures and Company tax treatment
  • How to organize company meetings
  • Establishing a Company bank account, signatories, and treasury powers among members

It is essential to maintain corporate formalities when you have a California corporation or limited liability company. The Company must notify the Secretary of State of any change to the business name, principal address, or any changes to the name and address for the agent for service of process. The Company should also give notice to the State if it ceases operations by dissolving the Company.

The Company should have its bank account and a Federal Employer Identification Number. This way, the Company does not co-mingle its assets with the personal funds of any member.

If the Company fails to observe corporate formalities, the members may find themselves subject to default rules on the governance of limited liability companies established by the State of California.

Using an Operating Agreement for buyout

The Company should consider potential future issues, such as death, disability, or divorce of its key members. In some cases, members may wish to leave the Company, or the Company may want to buy out a member. When that happens, the business should be ready to follow established procedures to provide the departing member with a fair market value in compensation for their interests.

For example, suppose a business wants to expedite its buyout process. In that case, it can use an Operating Agreement to empower the Company to hire a neutral Certified Public Accountant to perform a valuation. Typically, the accountants perform the valuation by reviewing the Company’s gross revenue, liabilities, goodwill, and the possibility of future growth to determine the Fair Market Value (FMV) of the Company. Assuming that the members identified their initial capital contributions and percentage ownership stakes, they will all be in a much better position to negotiate a less complicated departure for any member who needs to transition away from the Company.

Another consideration would be to leverage insurance policies such as life insurance, key man insurance, or disability to facilitate a buy-sell in the event of the death or disability of a key member. A right-of-first-refusal can give remaining members the ability to buy out a departing member’s interest using insurance policies naming to fund a buy-sell agreement.

These are just a few reasons a business should consider developing a thorough Operating Agreement as part of its general business planning. If you have any questions, feel free to reach out to one of our experienced small business lawyers at (858) 926-5797, or contact us online or at info [at] tomgallagherlaw.com.

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