What is an operating agreement?
An operating agreement is a contract between the parties that outlines in detail her or his right and responsibilities. An operating agreement for a WI LLC is intended to govern the management of a limited liability company. In other words, the purpose of an operating agreement is to define the relationship between the owners , and shall include how the business is operated and how the profits will be divided. This is especially true for LLCs with multiple members. A well drafted operating agreement can reduce the risk of disagreement between the owners. If you do not have an operating agreement in place, Wisconsin law will apply to how your business is set up and run. This is usually not to your advantage.
Legal necessities in Wisconsin
So, if having an Operating Agreement in place for your Wisconsin LLC is such a good idea, how come it’s not required? All states have their own requirements under state law – including Wisconsin. The thing to note is that Wisconsin does require that you have your LLC be registered with the state – and that information is made publicly available. This tells the state who is running the LLC, but it doesn’t necessarily indicate who actually owns the LLC.
Andrew B. Sturm of MPress Magazine notes that "LLCs are created by state law; however, each member must establish and maintain an LLC Operating Agreement." While the state requires that you follow their rules, it does not dictate how you and your fellow members within your LLC create your internal rules or policies. A business agreement is still a necessary part of operating a business, but it can be done informally if you wish. An Operating Agreement creates a written record of your and your fellow members’ intentions – and therefore protects you if a question arises.
Having a written record will help prove to the State of Wisconsin, other members or even the members of a competing business, that your business structure observes the limits of an LLC. For example, if your business has been sued, the attorneys for the plaintiff may try to go after you personally – if your LLC does not have a written Operating Agreement in place like most Corporations, then the implication is that the members are not regarded as separate from the business. They may therefore try to argue that you are personally liable for any debts of the business.
So, even though the State of Wisconsin does not mandate that an LLC establish an Operating Agreement, it is still recommended that you do so for the protection of yourself and the other members and the corporation itself.
Essential parts of a solid operating agreement
An operating agreement is a crucial document that lays out the structure and rules under which an LLC in Wisconsin will function. It can have many sections, but we’ll go over the key ones.
• Name and Address of the Business: The physical place where the LLC will be housed or operate through. This should include its principal place of business as well, which a lot of people designate out of state, usually Delaware.
• Names and Addresses of the LLC Members: Essentially everyone who has a stake in the company.
• Duration: The clauses and articles in regards to the LLC’s life can range from perpetual to time-limited. It can even contain specifics in regards to what happens when a member wants to leave or dies, or if the business ends up dissolving. It is not uncommon for members to say that the LLC will only exist until the project it was formed for is completed.
• Purpose: This will outline the purpose of the business and what activities the company will participate in. As with the duration of the business, this section can be very specific. Some businesses form a vague statement just because they want to expand into new fields, while others want to lay out a plan for what they will not do in the future.
• Capital Contributions: This outlines what each member has put in to the business in terms of money or assets.
• Management of the LLC: A big reason to have an operating agreement is to specify how the management of the LLC functions. The default rule is that each member has equal authority for management, but this can be changed with an operating agreement.
• Allocation of Profits and Losses: Tax duties and the percent of ownership each member holds in profits and losses, whether it’s one for one or in multiples.
• Loss Limitations: This basically limits what each member could lose.
• Distribution of Profits and Losses: Similar to the above section, but with actual profits.
• Terms of Amendments: This lays out how the operating agreement can be amended and adds some guidelines for how that happens.
In addition to these sections, operating agreements will often specify transfer of ownership and what happens in the case of a member being released from their duties in the LLC.
Why have an operating agreement?
Operating agreements provide a solid foundation for limited liability companies (LLCs) and their members. They clearly outline the management structure, member obligations, and the terms of ownership for members. Further, operating agreements can prevent members from having to dissolve the LLC by establishing guidelines for specific situations.
Because they set forth many issues that could arise in the operation of an LLC in Wisconsin, operating agreements provide extra protection from conflict among members. In addition, an operating agreement can help to shield personal assets in the event of litigation, since it can clearly define the distinction between the LLC and the members.
Whether a Wisconsin LLC has an operating agreement or not, the law imposes certain duties on members in order to protect each member as well as the LLC. Specifically, fiduciary duties require members to act in the best interest of the LLC. When a member violates this duty, or the duty of loyalty, he or she may be held personally responsible.
Fine-tuning your operating agreement
One of the primary purposes of an operating agreement is to articulate the specific rules and guidelines by which an LLC will run. For this reason, it’s essential to tailor your operating agreement specifically to the individual needs and wishes of your business. While there are several default provisions that apply to most LLCs in Wisconsin (as is the case with many states), you could find that these rules may not match the unique structure of your LLC. Without customizing your operating agreement, you may be subject to a number of provisions you don’t want your business to be beholden to , or you could end up having no protection at all against certain issues that might arise during the process of running the company. When you write your LLC’s operating agreement, you have total control over the provisions contained within. To effectively customize an operating agreement, first consider what your specific needs are as a business owner, and what you intend to do in the future with the company. Some of the most important questions you can ask yourself include: Using the answer to these questions, you can make sure you’re customizing your operating agreement to the needs of your LLC and yourself.
How to draft an operating agreement in Wisconsin
Operating Agreements in Wisconsin are subject to two sets of mandatory rules. The first are the limited liability company statutes themselves. The second set of rules comes from any agreements the members reach among themselves to tailor the company to their specific needs.
Operating Agreements are contracts among the members. The members, therefore, have to negotiate their terms and put them into writing. Care should be taken to make sure that if one term requires a certain format, that all similar terms conform in order to avoid unintentional ambiguities.
There is no prescribed form for an Operating Agreement in Wisconsin. All that the law says is that the members can agree to whatever terms they want for their LLC so long as their agreement isn’t "inconsistent with the provisions" of the Wisconsin statute. The statute allows each member to carry away a copy of the signed Operating Agreement, but only until the members all agree on a different method of record keeping.
At the very least, the members should agree to a method for meeting once or twice a year, creating a method for calling special meetings and a method for voting by orphans, which are the members who have not been given a formal method for voting or who haven’t voted for a period of time. The members should also address how distributions will be handled, whether to add or remove members, and financial books and records. Essentially, the Operating Agreement should cover all the topics the members want to address.
The members can create an Operating Agreement themselves, but they are well-advised to have an attorney assist them with their drafting efforts in order to avoid any inadvertent pitfalls.
Common pitfalls
A well-crafted operating agreement for a Wisconsin limited liability company (LLC) should be tailored to the specific needs and goals of the owners. However, you should avoid a few common pitfalls:
Failing to Prepare or Update the Operating Agreement. A written operating agreement is not required for an LLC, but it is best practice to create one, even if solely to avoid disputes among the owners and alleviate uncertainty over key rules. An operating agreement will give the members peace of mind that there is a defined plan if the business has to be sold or ends in dissolution or bankruptcy. It will also address other issues that may arise, including whether owners can participate in other businesses, what constitutes a default and what steps to take if there is a deadlock vote. Given the ongoing evolution of your LLC’s business arrangement, the operating agreement should be periodically reviewed and revised as appropriate. Update the agreement if there are major changes to the business, such as a new member, a change in the ownership structure or a shift in the focus of the business. If you don’t do this and then attempt to amend the agreement later, the amendment will not be valid if you do not follow the procedures required by the original agreement. You should also consider drafting a new agreement if you treat your business as a partnership for tax purposes, because rules related to taxation are far more strict than rules regarding LLCs.
Not Complying with the Operating Agreement. LLCs are creatures of statute and to be recognized as such , they must adhere to regulatory requirements outlined in the statutes. A failure to adhere to these requirements can lead to various adverse consequences to the LLC and its members including the loss of limited liability. You may also face adverse tax results with respect to distributions, transfers and terminations of an LLC. Generally, coupled with the operating agreement, the LLC should do the following:
Not Having Members Agree on Key Provisions. Key provisions include: (1) how decisions will be made in the event there is a deadlock among the owners, (2) what will happen if a member wants to leave the company or receive more capital contributions, (3) whether ownership interest may be transferred to third parties without the other owners’ approval, and (4) how the proceeds of the business will be divided up upon dissolution. Disputes and shareholder deadlocks lead to litigation, which is costly and can tear apart a business. If your business partners cannot agree on the key terms of the operating agreement, it could very well be time to rethink your business arrangement.
Not Consulting with an Attorney. Failing to communicate with an attorney can cost members time and money long after the deal. Each entity is different and has different needs, so an attorney can customize an operating agreement to fit those needs. The legal aspects of the deal will often come up in ways that were not originally contemplated when preparing a contract. An experienced attorney can provide advice about interpretative conventions amongst member, evaluate a potential conflict of interest in a transaction, and ultimately reconstitute the agreements on the back-end. It pays to get it right from the start, so consult with an attorney versed in LLCs and their operating agreements.