When I draft LLC operating agreements for clients, or when I review ones that someone else has drafted, I look at them with eight bad “D”s in mind that need to be addressed in detail in every operating agreement for a multiple-member LLC. This is the first in a series discussing these eight important things to consider.
Whenever you have a multiple-member LLC, meaning you have more than one owner, you have the potential for disagreement among the various member-owners. The operating agreement for the LLC needs to clearly spell out how that disagreement is going to be resolved. The scenario I frequently see, which results from poor draftsmanship, is when there are two 50-50 owners of an LLC and no tiebreaking mechanism has been put in place. Here are some simple but effective mechanisms I’ve seen used:
- When there are three or more member-owners, a vote is held based on percentage of ownership, and a 51% or greater majority vote carries. While this sounds simple and effective, it can also lead to a great deal of resentment and distrust by the minority owners.
- Do a coin toss. Seriously, I have seen that suggested for any sort of disagreement on an expenditure of $10,000 or less.
- I personally believe that a neutral third party should be agreed to in advance, someone all LLC owners respect, who will make the tiebreaking decision. Obviously, you want to reach out to that neutral party and get their consent to name them as the tiebreaker or arbitrator. It’s important to set out in the operating agreement the procedures by which each party presents their case to the neutral third party.
When more than one person is involved in a business, things can go sideways when they don’t see eye to eye on business strategies, moves, etc. You need to plan in advance for that. If you fail to plan for the disagreements that will eventually happen, you are planning to fail.