Without an Operating Agreement, your business is left at the mercy of Michigan’s LLC default rules, which may not be ideal for you
-Authored by: Linda Isho
Your business outlook may seem promising when you initially contemplate starting a business with a close friend or relative. You set up a Limited Liability Company (LLC), a separate legal entity, to help protect your personal assets in the event of any claims brought against the business. You and your partners may see initial financial success with the business. You may think that things could not be going better. But then reality sets in when you and your partners begin having disagreements over business decisions or profits distributions. Circumstances quickly escalate into a “he said, she said” mess and, as we all know, that never ends well.
As it turns out, you could have avoided this mess by having an Operating Agreement in place to address exactly how business decisions must be handled. An Operating Agreement is a written agreement used by an LLC to lay out the rules and regulations by which the business will operate, and all LLC members agree to abide by the terms of the Agreement. Although such an agreement is not legally required in Michigan, it is undoubtedly in the best interest of all involved to have one in place. The Operating Agreement gives the owners (members) of the LLC control over their own business, and without such control, the state of Michigan holds the reins of your business by enforcing default LLC rules.
Michigan’s LLC default rules can have a harsh result at times. Consider a scenario where things are going downhill for the business or you and your partners are constantly having conflict. You decide that you want out of the LLC. Unfortunately, the default rules state that a member of an LLC does not have the automatic right to withdraw. Withdrawal from the LLC is only permitted to the extent it is allowed within an Operating Agreement.
Now imagine the scenario where you end up doing all the work for the business and contributing over 95% of the capital, while your partner is only contributing and doing 5% of the work. The non-contributing partner will still get that 50/50 distribution of the profits under the default LLC rules, regardless how little they have contributed.
There are countless circumstances where an Operating Agreement will be beneficial during operation of your LLC. Essentially, the Operating Agreement provides an avenue to alter the default rules for your LLC in a way that is ideal for those involved. It may cover topics such as election and removal of managers, how distributions should be handled, withdrawal terms, voting, transferability of interest, indemnification, and membership requirements – just to name a few. And use of an Operating Agreement is valuable regardless of the size of your LLC. It is a common, and mistaken, belief that you cannot have an Operating Agreement for a single-member LLC. In fact, a 2002 amendment to the Limited Liability Company Act (LLCA) allows a single-member LLC to have an Operating Agreement in place.
An Operating Agreement that effectively guides your business decisions must be tailored to your LLC’s purpose and needs. If your LLC does not have an Operating Agreement, please contact our office today to set up an initial consultation.