What Is an LLC Operating Agreement?
An Operating Agreement for an LLC, is a necessary document to have prepared for any business that is formed as a limited liability company in the State of Ohio.
The Operating Agreement is very important for the operation of an Ohio LLC, explains how the LLC will be run, and many times has provisions that differ from what is the default statutory rules for the management and operation of an LLC under Ohio law.
An example is the default rules under Chapter 1706 of the Ohio Revised Code. However , an LLC Operating Agreement can have rules that also apply to managing the LLC that differ from those default rules. So, it is important to not only have an Operating Agreement that is drafted, but to also ensure that the Agreement accurately reflects what the members of the LLC want in terms of its operation.
The Need for an Operating Agreement in Ohio
Even if you’re not required to have an LLC operating agreement in Ohio, you should because it sets the tone for how the LLC will be run. The Ohio LLC law actually states that unless an operating agreement is in place, the LLC will be governed solely by the law of Ohio. So if you can imagine a scenario of being in a courtroom with a judge who is interpreting the law and applying it to your LLC situation, you are rolling the dice if you have not customized your LLC with an operating agreement.
It is not enough to presume that you qualify as just a single owner LLC using a schedule C. Operating with just a schedule C is not sufficient for the judicial system if an issue or dispute arises. It is far better to take the time to do an operating agreement than to spend time negotiating (and paying attorneys) to try to resolve an issue later.
The benefits of having an operating agreement in place include but are not limited to the following:
An operating agreement can help minimize conflict among the members and managers of an LLC. By clearly defining the rights and liability of each member and manager, an operating agreement typically helps avoid misunderstandings, arguments and, ultimately, lawsuits.
With an operating agreement in place and having been executed by all of the members and managers, the continuing existence of the LLC, together with the powers of its members and managers, and the responsibilities for its debts and liabilities, can be clearly established and easily recognized by third parties, including government authorities. To the extent that statutes, regulations and requirements of governmental authorities attempt to impose restrictions or limitations on members, managers or the ongoing operation of the LLC, an operating agreement is usually able to modify, revise or eliminate such duties, standards or restrictions so that it will be consistent with the terms and conditions of an operating agreement.
In other words, an operating agreement is a way to override Ohio law and tailor a business agreement that fits your needs.
Essential Elements of an Ohio LLC Operating Agreement
The operating agreement for a limited liability company in Ohio is a contract between the members that establishes the composition and operation of the business. While not required by law, a comprehensive operating agreement can help prevent misunderstandings and disputes among the owners of an Ohio LLC. Following are some of the key components that should be considered when drafting an Ohio LLC operating agreement.
Management Structure
One of the most critical decisions affecting the operation of an Ohio LLC is whether it will be member managed or manager managed. The management structure of an Ohio LLC can be determined by the members when they first form the business. In a member managed Ohio LLC, all members share in the responsibility of managing the company. The decision to operate as a member managed LLC should be discussed in detail with a lawyer. If you choose this option, you’ll need to include in the operating agreement how decisions are made, how voting rights are allocated, and how much input each member has in the daily management of the company.
In a manager managed Ohio LLC, the members appoint one or more managers to run the business. The operating agreement should outline what authority the managers have. For example, while managers should be given authority to enter contracts and perform other managerial duties without the consent of the members, some decisions may be too big for a manager to make without input from the members (like selling or transferring the entire interest of the company). Discuss with your attorney what decisions would warrant a vote of the members.
Voting Rights
The operating agreement should include a clause that sets forth voting rights of each member of your Ohio LLC. For example, you may agree that each member has an equal say in the management of the business, regardless of how many units of the Ohio LLC they own, or you may choose to allot voting rights based on percentage ownership. Clearly delineate in the operating agreement how voting rights will be allocated.
Profits and Losses
Like voting rights, you must clearly set forth how you will distribute profits and losses of your LLC in the operating agreement. You may choose to distribute profits and losses based on percentage of ownership or some other formula. Whatever you decide, it’s important that you spell it out in a written document so all members know what to expect.
Membership Changes
If you intend for members to be able to change frequently, you should specify the procedures for membership changes in your operating agreement. Generally, the LL comes into play at this point. Will a member only be able to exit the business with consent of the other members? This all needs to be agreed upon and documented in the operating agreement.
While the above is by no means a full list of every provision that should be included in every Ohio LLC operating agreement, it’s a good starting point for ensuring you cover the key components that should be addressed when creating this essential document.
Creating an Ohio LLC Operating Agreement
When you sit down to draft your Ohio LLC Operating Agreement, you will want to have the following information available. We recommend, before a meeting with a legal professional, to gather the following information:
- the registered name of your Ohio operating LLC, which can be found on file with the Secretary of State;
- whether the Company will be managed by its members or by a manager;
- the percentage of ownership (or other form of allocation) for each member;
- the distribution of profits, losses and liabilities for your operating LLC, which can be the same percentage as the ownership allocations or something other than the allocations; and
- the time period prior to which members must notify the Company of a proposed transfer of ownership interest (from member to member or to a third party) and the manner in which a member must notify the Company of that proposed transfer.
Now that you know what information you need, there’s no need to go it alone. While it is perfectly permissible for members to draft their Operating Agreement, we recommend that the initial draft be done with the consultation of a lawyer (or law firm) in order to ensure that the document is drafted properly. Once the drafters have run the first draft past a licensed professional, the members of the Company should obtain a quote for review and/or further drafting.
Some sources for obtaining Ohio LLC Operating Agreement templates include the Ohio Secretary of State’s website, an attorney who works with LLCs, and the American Bar Association.
Operating Agreement Creation Errors
Membership interest ownership; the percentage of ownership that an individual has in the LLC.
Assignment of LLC Interest; the transfer of ownership of the membership interest.
Earmarking distributions; a document that directs the use of distributions that are received. Often this document designates that the distributions are to be deposited into a separate account for future use for a child, home, or other item.
As with all contracts, there are common mistakes that occur throughout the creation of the operating agreement. One of these is using vague language. No matter how simple or complicated the operating agreement is, you should avoid language that is not specific . Doing this will help to make certain the language is clear, specific and accurately reflects the intent.
Another common mistake is not keeping the agreement current. The operating agreement should be updated as policies change or as the goals of the LLC shift. Often changes can occur when new members are added or a member leaves.
One more common mistake is not hiring counsel to draft and create the operating agreement when necessary. Some LLC members opt to draft and create the operating agreement without seeking legal advice. The terms can frequently be complicated, and it never hurts to have the advice of an attorney.
Amending an Ohio LLC Operating Agreement
Once an LLC Operating Agreement is signed by the members of an Ohio LLC, it becomes the governing document of the business. However, circumstances change over time and the information contained in the Operating Agreement may no longer be accurate. When this happens, a new Operating Agreement may need to be created that reflects the new goals and objectives of the business. Fortunately, any Operating Agreement can be amended at any time, even if the existing document does not contain an amendment provision. Ohio law (O.R.C. 1705.22) requires only a unanimous vote by the members to modify the terms of an LLC Operating Agreement, unless the document provides otherwise. An Operating Agreement that stipulates a super majority of members or a different threshold vote must approve all amendments is not very common in my experience. Even in cases where an Operating Agreement does not specifically address amendment procedures, I highly recommend obtaining approval for a proposed amendment in writing, whether that means drafting a new Operating Agreement or revising just part of the existing document. All members should sign off on the amendment to prevent any issues in the future with a member who claims to have not been present when the proposed amendment was passed.
Ohio LLC Owner Resources
For those interested in learning more about the Ohio operating agreement, below are some resources for Ohio LLC owners:
State of Ohio Website Offering Ohio LLC Information:
The Ohio Secretary of State has a webpage dedicated to providing Ohio LLC resources. The resources include links to different legal resources and forms for the Ohio LLC owner to file with the Ohio Secretary of State.
Ohio LLC Operating Agreement Template:
Our Ohio LLC Operating Agreement includes sample provisions that can be used for your Ohio LLC.
Legal Service Providers Available to Ohio LLC Owners:
In addition to our law firm that offers Ohio LLC services , there are also other law firms in Ohio that offer LLC formation and Ohio LLC operating agreement services.
Various online legal service providers are also available to those seeking to have an Ohio LLC operating agreement created or evaluated. These companies offer various forms and templates for use when sought to draft an Ohio LLC operating agreement.