Forming a new business entity with other owners? You have several choices. If owners want limited liability protection, the decision often comes down to choosing between a corporation and a limited liability company. Each offers limited liability protection for its owners. If the owners want flexibility in structure and operation, the limited liability company is likely the best choice. While tax issues may end up driving the decision, I will ignore tax issues for purposes of this discussion.
The governing documents for a corporation and a limited liability company are very different. The typical governing documents for a relatively simple corporation are articles of incorporation and bylaws. In addition, the shareholders and the corporation often enter into a stock agreement detailing stock restrictions and buy-out provisions. These documents tend to follow standard formats and, with respect to the articles of incorporation and bylaws, a well defined statutory structure.
The governing documents for a limited liability company are articles of organization and an operating agreement. The articles of organization are usually a simple one page document. The operating agreement for a business with multiple owners on the other hand is often a rather long and complicated document.
One advantage of a limited liability company is that it is a very flexible entity. It is more flexible than a corporation in terms of governance and internal operation as well as in financial matters. However, as a result of this flexibility, the operating agreement can be long and complicated. It must address a number of choices made by the LLC’s members.
In terms of governance and internal operation, the operating agreement may provide for management by all of the members or by a select group of members or by a single manager or multiple managers. In each case the agreement will describe the authority and limits on authority of those managing the business.
With respect to financial matters, the operating agreement will set forth who contributes capital and in what proportions, how profits and losses are split among members, and how and when distributions are to be made to the members. Within certain limits imposed by tax law, capital contributions, profit and loss sharing, and distributions do not have to be in the same proportions and distributions to each member do not have to be at the same time or in the same priority. Unlike stockholders holding a single class of stock in a corporation, each member in a limited liability company can be treated differently, all as agreed and set forth in the operating agreement.
The operating agreement typically includes restrictions on transfer of membership interests as well as buy-out provisions. How and when a buy-out is triggered and how to determine the purchase price and terms of sale can be difficult questions upon which the members must agree.
In summary, the LLC is the flexible choice. However, because of that flexibility and the resulting comprehensive nature of the operating agreement for a multiple member LLC, the operating agreement can be a complicated document. The members and the drafter must give careful thought to its structure and content.