06 May Do I Need an LLC Agreement?
This is the most common question asked by an owner of a new company: “Do I need an LLC Agreement?” The short answer is a resounding “Yes!” But what follows might be the second most common question asked by an owner of a new company: “Why?” The answer to this question surprisingly includes both legal and non-legal considerations.
Take, for example, two friends who have a mutual interest and quickly realize they can make some money doing something they enjoy. A win-win no doubt, but it’s easy to get caught up in the development of the idea, watching it materialize, and start reaping the rewards without considering those “worst case scenarios” that are usually addressed in LLC Agreements. What happens if your friend (now business partner) loses interest in the business? Or if you have different perspectives on the future direction of the business? Or your friendship turns sour and the former friends are now reluctant business partners?
These are all events that may happen, but that doesn’t mean they will happen – this is the heart and soul of an LLC Agreement. An LLC Agreement can be viewed as a safety net for business partners to put into writing at the beginning of their business venture these worst case scenarios and how they plan to address them if they ever occur. In many cases, an LLC Agreement is negotiated, agreed to, signed, and then never looked at again, granting the business partners the peace of mind of knowing they can tackle any future worst case scenario if needed.
But beyond those feelings of security, a properly prepared LLC Agreement satisfies the expectations of professionals you’re likely to do work with at some point in your career as a business owner. For example, when you apply for a bank loan through your company, the bank will ask for a copy of your LLC Agreement; when you buy or sell property, the title company will want to review your LLC Agreement; if you were to secure an investor for your business, that investor will want to know his or her rights and obligations, all of which are identified in LLC Agreements. Not having an LLC Agreement can create a hurdle to completing these corporate transactions, or even worse can manifest into a business owner trying to quickly get some sort of LLC Agreement in place to these professionals to satisfy their expectations, and the resulting product may not adequately address the business owner’s needs or protect their interests.
And last, but certainly not least, a properly prepared LLC Agreement protects your rights as a business owner. An LLC Agreement should address concepts such as how profits are allocated among the owners, how and when profits are distributed to owners, who has the ability to act on behalf of the business and what powers do those people have, and the voting thresholds to approve certain actions and what actions require a vote (for example, an owner selling his equity, adding a new owner to the business, selling the business, amending the LLC Agreement, etc.). These provisions do more than just protect the business owners’ interests – they also put all of the owners on the same page as to what each owners’ rights are and their obligations to the business.
Texas has done all it can to encourage people to enter into LLC Agreements. Limited Liability Companies are creatures of contract, not statute – the Texas Legislature created the LLC laws (under the Texas Business Organizations Code) to encourage business owners to adopt an LLC Agreement by having the LLC Agreement trump mostly all of the provisions contained in the Code, if an LLC Agreement is executed. If the owners of a business do not adopt an LLC Agreement, they will be bound to the LLC laws contained in the Code, which are not as comprehensive as you may think, and may not be as fair as you might like (for example, the Code provides 1 vote for each owner instead of voting in accordance with the owners’ ownership interest in the business, so if one owner has a 99% interest and the other owner has a 1% interest, under the Code each owner has 1 vote, which creates a deadlock if they do not agree). By entering into an LLC Agreement, you can save yourself from being subject to these draconian provisions in the Code, and can tailor the agreement to meet all of your needs, protect your rights, and grant yourself that peace of mind.
ABOUT THE AUTHOR: Drew Erickson is an Associate at Rapp & Krock, PC in the Business Transactions group advising clients on corporate governance matters as well as mergers and acquisitions and other business transactions.
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