8 Stupid Mistakes in Your LLC Operating Agreement

- Hey guys, this is Clint Coons with Anderson Business Advisors, and in this video, we're going to talk about some of the

stupid

(graphic)

mistakes

people make when it comes to creating their LLC

operating

agreement

s. (graphics whistling) Very good. Let us begin. (upbeat music) Well, I'm going to talk about some

mistakes

that I see, often, when I review existing

operating

agreement

s that people have established with inexperienced attorneys who are not familiar with creating operating agreements for real estate investors. Or worse yet, you connected to the Internet, right? You went to Legal, I mean Zoom.com, and you said, “Give me an operating agreement.” And you think you're protected.

This happens all the time. People have these operating agreements under which they own real estate. They are operating their business underground and don't know what is there or more importantly, they don't know what is missing. And as a result, this will come up when you are involved in a lawsuit and it could come back to haunt you. Well, I want to give you eight problems that I see a lot in operating agreements that you should avoid when crafting

your

LLC operating agreement. Well, which is the first? The first problem I have will be managed by members.

Alright? (squeaky scoreboard) We don't want to be member managed. If you're not familiar with this, when you create an LLC, you have different styles of running that business. It can be managed by an administrator or managed by a member. Now the reason I don't want to be member-managed is because in a member-managed context, all members can exert control. So if you want to do something in the future, like gift a portion to

your

children, and then you want to sell the property. Guess whose permission you have to get? Your children'. You want to refinance the property.

You have to get your children's permission to do it. Keep that out of there. So the other problem with membership management is that when you present it to the Secretary of State, many times the Secretary of State would like to know who the members are. If you set up a member-managed LLC, then they want you to list the members. So now you reveal to the world at large that you own this LLC. There's not much privacy there. The other side of the coin is what is known as a manager-managed LLC. And even though you're going to be the member and the admin, I still like to set them to admin-managed, because it tells everyone, hey, this is a person who's in control.

They run the company. If you later give ownership to your children or someone else, you still have control and never lose it. Therefore, I would avoid the member manager and always go for limited liability companies managed by a manager, unless you are using one of my strategies where we seek anonymity. Then forget what I just said. But when you're setting up an LLC, and you're not doing the anonymity side, and you can watch my other videos on that with Wyoming limited liability companies and setting it up, it's going to be a little bit different in that context.

Okay, number two. This is bad. Number two will be forced distributions. (marker squeaking) Okay, so what does that mean? So, in a limited liability company, you have the ability to distribute money to each other. That's called distribution. Then you have your LLC. Let's say here is my LLC. It has some money inside. I am a member and withdraw money. Well, when I withdraw money as a member, that's called distribution. Now, the problem I run into, as you will see in the operating agreements, is that they have provisions that require the company to distribute profits annually to its members, or to distribute enough money to its members, to cover its tax liability.

Now, that may seem cool at first when you look at it. Hey, cool. I get money from my company. But remember that it is your company. You control it. Why do you need to have an operating agreement that tells you what to do? Why not allow the operating agreement to give you discretionary authority to make those distributions? Here's why it's important. Suppose they sue you and obtain a judgment against you. And they file a charging order with their limited liability company. And you already know everything about collecting orders, if you have been a member of my channel for a while, you do not have to distribute money, the creditor does not receive payment.

But wait a minute. Your operating agreement no longer gives you that discretion, because your operating agreement requires you to distribute money outside of it. Do you see what can happen? A judgment could be entered against you, a charging order against your LLC. You sit back and say, "Well, this company doesn't do distributions." They pull out their operating agreement and say, "See here? It says you have to distribute all profits annually." So that's a trap. Don't include any language there that forces you to make distributions. Which brings me to the third point of this. You want to make sure that your operating agreement has what are called non-prorated distributions. (marker squeaking) Okay?

That is another important clause that goes hand in hand with that. And with non-prorated, what it means is that if there are multiple members in your LLC, you don't have to make equal distributions. Let's say I created this limited liability company and I have another partner involved. And this couple, here, is going through a divorce. And then that couple doesn't want to take out money right now, because that will only complicate their divorce. That's why they want to keep the money within the company. Well, what does that do to me? Then I need the money. I want to get the money.

Well, if these are prorated distributions and we have $100,000 here, then you would have to split it 50/50. 50/50 like that. So I would get 50,000, and my partner here, she would get 50,000, and then possibly that money would go to the lawyers, be spent, and disappear. So if I have non-prorated distributions, it allows me to take my money and I don't have to give it to my other partner. Think if you had children involved. Same scenario here, right? You might have a couple of kids involved in your LLC at some point in the future, just because they are there doesn't mean they will make money.

You decide who takes the money from the entity and it does not have to be the same. Therefore, you will want to create your entity without proration. And you'll see that in the distribution clause, Okay, the fourth topic will be (squeaky marker) no-charge command language. Well, it's important to have this in your LLC to indicate that in the event that a member is under duress, your company, if a charging order is issued against them, doesn't have to distribute money to them, they can't take away your interest. from you, that if a court attempts to adjudicate your interests, you become an assignee.

Not having charging order language in your LLC agreement that addresses these issues can be a problem. If a lawsuit develops and a judgment is entered against you, you may lose your interest, or the person to whom your interest is granted, a lawsuit may take control of your business. So you want to make sure you limit that. Which brings me to my next point, five, (squeaky) restrictions on transfer. Well, what we should really write here is no transfer restrictions. You need to make sure you have this type of language so you can restrict who can become a member of the LLC.

So, by putting restrictions in your operating agreement to restrict the transferability of your interests, you prohibit or make it very difficult for a creditor to obtain your interests. But more importantly, if you use your LLC in the future for estate planning purposes and, again, bring in other people, you will know who you are getting involved with. The worst situation you could find yourself in is for that person you are working with now to transfer their interest to someone else. And now you're in business with someone you've never met. Who wants to be in that situation? But if you have transferability restrictions to prevent people from being able to transfer their interests or to anyone at any time, then you can be sure that the members will remain the same unless you agree to the transfer.

So transfer restrictions are really important. Number six, okay, inadequate tax provisions. Alright? (squeaky marker) Improper tax. What does this mean? Well, an LLC is a hybrid entity. So, in a hybrid entity, you can choose how you want that entity to be taxed. You can be taxed as a C corporation, S corporation, partnership, or disregarded entity. (applauding) Many operating agreements are drafted as partnerships by default, but then the client chooses to set them up as a C corporation, or an S corporation, or maybe even a disregarded status, so it doesn't match the operating agreement. . So where you may run into trouble is with the IRS, which is either paying taxes or treating your entity as a corporation, but saying it should be a partnership.

So that could increase your taxes if you were audited. Or if you're involved in a lawsuit, someone might say, "Look, you have an LLC treated like a corporation, but your operating agreement conflicts and it's treated like a partnership. Maybe there's a benefit to creditors." Therefore, you want to ensure that the tax provisions included in your business agreement match the tax election that was made with your limited liability company. Okay, number seven, okay. (squeaky scoreboard) Right to return of capital. This is a problem when you have the right to recover the capital within that country. What it means is this, that if I contribute $100,000, then I am entitled to get that money back.

No, we don't want that. Good? Maybe, it sounds cool, something like forced distributions. You have to distribute the money to everyone annually. But think about this for a minute. If I invest $100,000 in an LLC that I control, I can withdraw it at any time. Why do I want my operating agreement to say that I have the right to get that money back? Because what that could affect you, down the road, is that if, again, if you're involved in a lawsuit, a judgment is entered against you, maybe a creditor has now found a way... Maybe they can't take everything, but they get a part of that company, because they come back, take over their interest and say, "Well, we have the right to receive our capital back.

Distribute our capital back to us." And they remove it. Therefore, you want to make sure that your operating agreement states that there is no right to return of capital. You do not want to be entitled to your money back. You have that control. You can decide if that will ever come back. And the last issue I see that I think is really important is the non-appointment of officers provision (squeaky scoreboard). Okay, so when we talk about limited liability companies, we're talking about member-managed or manager-managed LLCs. But guess that? You can also appoint officials. And here's the thing.

I like to have these provisions within my operating agreements to allow you to be president, secretary and treasurer. Therefore, you can operate as an office officer of that company and do not have to adopt the label of a manager when dealing with third parties or a member when dealing with them. Just tell them you're president. It gives you apparent authority, number one, to have this control. And then when you start to build an anonymity structure, as I've shown you in many of my videos, where you have a Wyoming LLC that owns LLCs within the state, it can be a little complicated for third parties to say, "Well, who has really in control here?" Well, now it's very simple.

If you have a provision in your operating agreement that allows you to name yourself president, make yourself president. And then you can say, "I have control of this company as president." And this is the good thing about it. When you have officer provisions within your LLC, you can name these people as officers. They do not appear anywhere on the secretary of state's website because that information is not collected. So you can control it without anyone knowing that you have control if they look at the Secretary of State's website. So it gives you some de facto anonymity there.

Having provisions for officers gives flexibility. Make sure you have that there. Here are eight of them. There are many more we could go through. I don't want to take time, but these are the eight key provisions, errors, that I see in many operating agreements and that you should review yours right now to make sure you have the protection you are looking for. . Alright guys, if you like the channel, give me a like. And if there are any comments about it, write some comments below and I will respond to them relatively soon to make sure you get answers to your questions.

Thank you. (soft music)