Vail Daily column: What is an operating agreement?
You might reasonably think an operating agreement has to do with doctors, scrubbed-clean surgical suites and anesthesia. You might ponder whether one has something to do with a disclaimer you sign with a trembling hand before you agree to undergo the knife. Yikes. But, nah, not so much. Instead, an operating agreement has not a whit to do with your medical self. Unless, of course, you are a doc and have entered into a business deal with other docs.
OK, time for me to explain.
Most of you are familiar with the concept of a corporation. A corporation may be defined as an organization formed with state governmental approval to act as an artificial person to carry on business (or other activities), which can sue or be sued and (unless it is nonprofit) can issue shares of stock to raise funds with which to start a business or increase its capital.
The “instruction manual” of how the corporation is to be governed, and what the rights are of the various shareholders is referred to as the bylaws. A more formal definition of bylaws may be phrased as the written rules for conduct of a corporation. They should not be confused with the Articles of Incorporation which only state the basic outline of the company, including stock structure. Bylaws generally provide for meetings, election of a board of directors and officers, the means of filling vacancies, the kinds of required notices, the types and duties of officers and committees, shareholder assessment and other routine conduct. Bylaws are, in effect, a contract among members and must be formally adopted and/or amended.
As an aside, there are (at least broadly speaking) three basic kinds of corporations: not-for-profit corporations; privately held (or subchapter S) corporations; and publicly traded (or subchapter C) corporations. The “S” and “C” mean, respectively, the associated subchapters of the Internal Revenue Code. Profits of a subchapter S corporation — which may have up to 100 shareholders — are not taxed at the corporate level but, rather, only at the shareholder level. Conversely, “C corps” are sometimes said to be subject to “double taxation” because these corporations pay income taxes on the corporate profit and shareholders pay income taxes on dividend payments that they receive from corporations.
When thinking of a C corp, think of Coke or Pepsi, General Motors, Ford or Chrysler. S corps, on the other hand, are more “mom-and-pop” in nature. One of the many things they have in common, along with nonprofit and more “exotic” types of corporations, is both types are governed by their respective bylaws which are tailored for the specific corporate needs.
Which brings us, in a round-about way, back to operating agreements.
ADOPTING LIMITED LIABILITY COMPANIES
For the past 20 years or so, limited liability companies — or LLCs — have been ascendant. Before that time, LLCs simply didn’t exist. Strangely, the first state to adopt the LLC as a form of business was Wyoming which has rarely been a leader in the legal world. Since that time, however, state after state has adopted the LLC as a legally recognized form of entity which, although similar in many respects to corporations, is distinctly different in others. Because of what is generally justifiably perceived as an LLC’s greater flexibility when compared to the corporate structure, more and more business have opted for the LLC form of doing business, especially when compared to an S corp.
As a quick aside; limited liability company, not limited liability corporation.
How the corporation and the LLC differ may include issues involving social security taxes, the ability to raise money, some differences in liability protections in some states, foreign ownership, management and other issues. Both, however — speaking generally again — provide at least substantial liability protection in every state in which they are recognized. Some of the tax distinctions between the two forms of doing business have been eliminated as an LLC may — on election of the members — be treated for tax purposes as an S corp. But that’s beyond our pay grade here. Suffice it to say, there are advantages and disadvantages to both.
Rather than beating around the bush, my attempt here has been to give this matter context. An LLC is like a corporation, only different. But that seeming non sequitur notwithstanding, what is clear is that both types of entities provide (limited rather than absolute) liability protection. And both require governance. Which is where, at last, the subject of the column rears its head.
LLC’S MANAGEMENT STRUCTURE
Rather than being governed by a set of bylaws, the LLC is governed by its operating agreement which — in broad scale — is much the same. The operating agreement is, much as the bylaws, a contract between what are referred to in the LLC setting as “members” rather than “shareholders” as in the corporate setting.
An operating agreement details the LLC’s management structure.
It typically provides the procedures for admitting new members, outlines the status of the LLC upon a member’s withdrawal and outlines the procedures for dissolution of the LLC. Unless state law restricts the contents of an operating agreement, members of an LLC are free to structure the agreement as they see fit. An LLC can usually amend or repeal provisions of its operating agreement by a vote of its members. In short, the operating agreement is a contract between members as to how they will cooperate together to govern the entity they each have part it.
Operating agreements and the surgeon’s knife? Nah. Not, that is, unless the surgeon and her surgical group have formed an LLC to perform their surgical practice.
In any event, whether an LLC or corporation is right for you, “going naked” in the business world almost never is. Beside the risks and liabilities, you might just catch your death of cold.
Rohn K. Robbins is an attorney licensed before the bars of Colorado and California who practices in the Vail Valley with the law firm of Stevens, Littman, Biddision, Tharp and Weinberg LLC. His practice areas include business and commercial transactions, real estate and development, family law, custody, divorce and civil litigation. Robbins may be reached at 970-926-4461 or at either of his email addresses, firstname.lastname@example.org or email@example.com.