Key Questions to Consider When Forming an LLC with Partners

While online "canned" LLC formations can work for single-member LLCs, a more tailored approach is critical when forming an LLC with partners.

November 4,2023 | Managing Your Business

While online “canned” LLC formations can work for single-member LLCs, a more tailored approach is critical when forming an LLC with partners.

When forming an LLC with partners it’s critical to create a custom-tailored, well-thought-out operating agreement that addresses various key questions. Here are some essential questions to consider when forming an LLC with partners.

How will the LLC be Managed?

Will the LLC be member-managed or manager-managed?

Most LLCs default to being member-managed. This means that the members, together, manage the day-to-day operations of the company. This can work for a single-member LLC, but when you have multiple partners and investors involved, it’s going to cause huge headaches and administrative burdens. You may find yourself issuing formal meeting notices and sitting in on votes for the most mundane of things far more often than you care to.

Instead, many multi-member LLCs will form as manager-managed entities, and delegate that day-to-day management authority of the business to one or more managers.

Who will be the LLC manager?

Assuming you choose to form a manager-managed LLC, you’ll next have to decide who that manager will be. Questions to discuss here include the following:

  • Will the manager be one of the owners, i.e., a member, of the LLC? Or will the company be managed by a consultant or an outsider hired for that purpose?
  • Will the manager be a person, or a company hired to perform management duties?
  • Are there any required qualifications for becoming a manager? For example:
    • Is there any reason the manager needs to be a real human instead of a company?
    • Does the manager need to be a U.S. citizen?
    • Does the manager need to be a woman because the company will be seeking women-owned and women-operated status with the SBA or some other similar organization? Is hiring a manager on the basis of gender or other protected class legal?

What limits should the members place on the manager’s authority?

The question of what limitations LLC members should put on a manager’s authority is always a tricky balancing act. On the one hand, it’s usually best for the manager to have broad authority so that the LLC can be agile and operate at speeds that are responsive to customers and vendors and the marketplace generally. On the other hand, it’s important to put guard rails around a manager’s authority to protect the LLC’s members from a potentially bad or incompetent manager, and at an extreme, to protect the LLC from fraud, embezzlement, and theft. So, some of the questions to consider when building those guardrails and balancing them against agility for the LLC include the following:

  • Will the members have to approve the manager opening or closing bank accounts?
  • Will the manager have signing authority on the LLC bank accounts? (And if not, who will have that signing authority?)
  • Will there be a limit on the manager’s signing authority for the LLC bank accounts? (Typically this is a dollar limit.)
  • Will the manager be authorized to sign contracts on behalf of the LLC? If so, is there a limit on those contracts? Are the limits dollar-based? Are the limits type-based? Or both?
  • Will the manager have any authority in winding up the LLC if and when it dissolves or shuts down? (Pro tip: A manager that has run an LLC for years might want to buy the company and continue it when the members are no longer interested in continuing the business. This can make the business more valuable to the owners. However, many state laws could prevent the manager from doing that if the manager is also responsible for winding up the LLC.)
  • What actions might the manager take in running the LLC that need to be approved first by the members?
  • Will the manager be allowed to operate or work for another company that’s a competitor of the LLC? If not, then how will the LLC and the manager determine what’s “competitive” such that the manager is prohibited from working with that other company?
  • How broad is the manager’s duty to present outside business opportunities to the LLC versus taking those opportunities for the manager’s own benefit?

How will the LLC manager get paid?

When it comes to how an LLC manager is paid, the sky’s (almost) the limit. Common arrangements include hourly pay, salaried pay, or pay based on equity interests, or any combination of those. If the manager isn’t also a member, LLCs often like having at least some component of the manager’s pay be equity-based, so that the manager is incentivized to build profits for and equity in the LLC. (If the manager is also a member of the LLC, then the manager already has skin in the game due to their ownership interest, so equity-based pay is less important for the member/manager.)

It will also be important to figure out the legal requirements that go along with any particular pay arrangement. For example, it may be legal to hire your manager as an independent contractor, or you may be legally required to hire them as an employee. If the manager is an employee, you’ll have to comply with salary, minimum wage, and overtime laws. There are also laws in many states that limit the extent of non-compete obligations that your manager may have to the company, and there can be heavy fines – for example $5,000 per contract in Washington State – if you don’t comply with those laws by drafting your management agreements extremely carefully. Finally, be aware that any equity-based pay arrangements – even if it’s only part of the manager’s pay – can have major tax implications for both the LLC and the manager if not drafted properly. In short, the opportunities to negotiate pay arrangements with your manager are rife with legal pitfalls, and we definitely recommend that you connect with an attorney to discuss the details of all manager pay arrangements.

How Will the LLC Handle its Members (Owners)?

Next, let’s take a look at some important questions around LLC membership. A “member” of an LLC is just another word for a person or company that is an owner of an LLC. It’s important to decide ahead of time how the LLC will manage its memberships to avoid disputes down the road.

What’s the process for new members to be added to the LLC?

Whether it’s sooner or later, most LLCs find themselves wanting to add owners or investors to their ownership ranks as they grow. So, it’s important to have a clear process on how that will happen. More often than not, the existing members must approve the potential new LLC member unanimously. That approval may be conditional on the new member contributing capital or other value to the LLC.

What is the process if a member wants to leave the LLC?

Sometimes, LLC owners decide to part ways, and it’s important that there is a clear process in the operating agreement for withdrawal of an LLC member. Does withdrawal of a member require approval of all other members? (Be careful with this one; you don’t want to end up stuck trying to do business with someone who’s no longer interested in doing business with you.) If a member leaves the LLC, do they get a buyout? How will that buyout be valued? How long with the LLC or the other members have to pay? What if the LLC or the other members can’t afford to pay?

What if a member can no longer participate in the LLC?

In most manager-managed LLCs, it’s not a big deal if a member becomes incapacitated because that member can put in place (and should put in place well ahead of time) a power of attorney that allows someone else to vote on the member’s behalf. But, when a member has certain duties to the LLC, it can become a point of contention if the member is no longer providing those services to the LLC. It’s important to consider in advance how the LLC should handle a situation where a member with certain obligations to the LLC can no longer perform those duties.

What if a member dies?

Now consider this: You’re happily in business with a great business partner, and suddenly that business partner passes away. You suddenly find yourself in business with your business partner’s 18-year-old kid, or that nutjob of a spouse you never understood. Your dream business has turned into a nightmare from having to deal with this person everyday.

This is why it’s important to figure out ahead of time, and write into your operating agreement, what will happen if one of the business partners passes away. Some companies’ operating agreements will have a mandatory buy-out provision of the deceased partner’s shares. Other companies will have side agreements, called buy-sell agreements, just between certain partners that set the deal structure for buy-outs of deceased partners. Other agreements will allow the deceased partners’ family to continue as owners in the company for purposes of receiving payouts, but without any voting or management authority. Still other agreements include hybrid and other arrangements.

If you do decide to go the route of a buy-out, consider agreeing in advance what the buy-out value will be. It can be an independent evaluation by a CPA; a dollar amount tied to the company’s financials; an agreed fee; or a variety of other creative valuation strategies. Whatever the arrangement, decide this up front to avoid disputes with estates and executors and angry family members later.

Can a member sell the member’s shares?

This is definitely a question most LLC owners don’t give enough consideration. But, like the deceased partner situation above, if you don’t address this up front, you might find yourself in business with a complete stranger if you’re lucky, and a complete nutjob if you’re not. So, it’s important to put limitations on when a member can sell the member’s shares to someone else.

One simple method of managing this is to simply say that a sale or transfer isn’t allowed without either majority or unanimous approval of all LLC members. Another option that many LLCs use is to allow the transfer, but give the existing LLCs members a right of first refusal.

Like many other terms of the operating agreement, these solutions can be infinitely tailored to fit the needs and expectations of the LLC and its members.

What administrative provisions need to be in an LLC Operating Agreement?

Now that we’ve covered some of the critical questions relating to LLC managers and members, there are some administrative questions to address. Those include the following:

  • When is a meeting of the members required?
  • How is meeting notice to be given?
  • Who must receive notice?
  • Who may call a meeting?
  • Can a meeting be online, or in person, or hybrid?
  • Does a majority vote mean a majority of a quorum present at a meeting, or a total majority of the LLC ownership?
  • Is member voting per capita or proportional per shares held?

Get All the Details of Your LLC Into Your Operating Agreement.

The questions above are only a partial list of some of the decisions that go into developing your LLC and its operating agreement, but they are critical to running an LLC peacefully when questions and conflicts arise. The questions above are also some of the main points our firm ends up litigating, especially in online and other “canned” operating agreements. If you work with an experienced attorney to work these questions out ahead of time and get a clear operating agreement, you are likely to save yourself and your LLC tens of thousands of dollars in the future.

At Skepsis Legal, we offer LLC formation solutions that will help you craft a partnership and an LLC operating agreement designed to last as long as your business. The operating agreement is your foundation, and it has to be solid to build a profitable business venture for all the LLC’s partners in the future.

Would you like to speak with an attorney about your LLC formation and your operating agreement? Click here to book a business attorney formation consultation today.

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