A limited liability company (LLC) operating agreement is a contract that accomplishes two primary purposes:
- Defining the structure and operation of the company
- Governing relations between the members
When it comes to LLCs, an operating agreement serves as a blueprint for the way those operations will be carried out and important decisions will be made.
Are LLC Operating Agreements Required in Colorado?
Although not mandatory under the Colorado LLC Act, operating agreements are a necessity (in our opinion) when more than one member is involved with the company.
A thoroughly drafted operating agreement will:
- Add strength for the “corporate veil” (i.e. protect your personal assets from the Company’s creditors);
- Solidify the rules that govern management and voting procedures (e.g., How are important business decisions made? If by vote, what are the necessary voting percentages?);
- Establish the economics of the company, including how profits will be allocated and money will be distributed;
- Give each member a clear understanding of their obligations within the LLC (e.g., does the member have to contribute more capital to the company in the future if it needs it?);
- Enable the owners to establish their own operating rules instead of following the comparatively rigid Colorado Limited Liability Company Act guidelines, which apply automatically in the absence of an operating agreement; and
- Allow Members to plan for the future with respect to both planned events (e.g., exits, financings, and sales of the company) and unplanned events (e.g., death or disability of a key member).
A lot of business owners assume that because an operating agreement is not required by statute, all they have to do to protect themselves from personal liability is file LLC Articles of Organization with the Secretary of State. However, relying on the statute to govern the operations of an LLC can be extremely problematic. For example, the Colorado LLC Act provides that in many cases, unanimous consent of the members is required to take certain actions. That could be very detrimental, especially when a nominal holder of interests withholds his/her consent.
Likewise, many business owners assume that operating agreements are “boilerplate” and “off-the-shelf” agreements that can be used, regardless of the circumstances. In fact, many will resort to online solutions to create an operating agreement.
One horror story that comes to mind was an entrepreneur who owned 95% of the LLC and gave a key employee a meager 5% for his “sweat.” The pair decided to “save” money and get an operating agreement from an online resource for a couple of hundred dollars. The default provision in the agreement stated that a sale of the company required unanimous consent of the members. Lo and behold, the key employee and the owner had a falling out, the key employee left, and the owner kept building the company. One day, the owner got a multi-million dollar offer to sell the company that he wanted to accept. But, the key employee, who was still filled with resentment, dragged his feet and slowed the deal to a grinding halt. The key employee then used his leverage to negotiate a better deal for himself.
This should have never been an option for the key employee. A well drafted operating agreement would have prevented this sort of scenario from ever playing out. How much do you think the business owner would have paid to go back in time and do the operating agreement the right way? Don’t be penny wise and pound foolish when it comes to setting up your partnership for success.
Our firm has produced hundreds of operating agreements and none of them have ever been the same. Each agreement is uniquely tailored to the needs, wants, and goals of the company and the entrepreneurs running it.
If you are planning to create a Colorado LLC alone or with other people and need professional assistance in drawing up an operating agreement, contact Doida Law Group today. We will help you start your new company off on the right foot by ensuring that the agreement contains the elements needed for success.