A limited liability company (LLC) is an attractive option for food and beverage entrepreneurs because it provides liability protection similar to a corporation and favorable income tax treatment similar to a partnership. Plus an LLC affords its owners flexibility to structure their operations and business relationships with their partners.
The terms of how the business operates is usually established in an operating agreement. While not all states require an operating agreement, it is highly recommended for businesses with 2 or more members. Most state laws contain default provisions for the many organizational issues that arise, but not all. Regardless of what state you operate in here are the most important provisions you should include in your operating agreement to make your business run smoothly.
1. Management Deadlock
Many food businesses begin with two partners excited to bring their new concept to fruition. Since this relationship is often formed out of a friendship, the owners frequently decide to split ownership 50/50. This situation usually works fine until the relationship sours and the owners disagree on a matter. If neither side will relent, then deadlock occurs. The remedy for deadlock in many states is for a court to order dissolution of the LLC, meaning that the business can no longer operate and must liquidate.
In a recent case, celebrity chef Gordon Ramsey sought dissolution of an LLC that that developed and operated burger-themed restaurants in Las Vegas. Ramsey owned 50% of the LLC and asked his partner to withdraw, but he refused. Since the operating agreement lacked a tie breaking mechanism, the result was a deadlock. In the end the court ordered the LLC to dissolve because deadlock between the parties rendered it no longer reasonably practicable for the LLC to operate in accordance with its operating agreement.
The Ramsey case should serve as a warning to other food businesses on the importance of addressing management issues upfront when the relationship between the parties is strong. A well-drafted operating agreement can avoid this potential fatal flaw and keep the business operating.
2. Transferring Ownership
You cannot predict the future so its important to plan for potential life changing events. The default rule in many states is that members may freely transfer a membership interest in the LLC to anyone, but the new owner may be treated differently, including not be entitled to vote unless a majority of members agree to make them full members. If members are freely allowed to transfer their interests they may find themselves faced with new business partners they do not want. In certain circumstances a member’s interest could be transferred involuntarily, such as death, divorce or bankruptcy. To avoid uncertainty in these situations members may want to put restrictions on transferability in the operating agreement.
3. Additional Contributions
As the business grows it may require additional capital. Many businesses turn to their members to supply the money, which is referred to as additional capital contributions. The law in most states provide flexibility in how LLCs deal with the need for additional capital in their operating agreements, such as members are not required to make additional contributions, or it may require additional contributions and permit one member to make an additional capital contribution for another member that fails to make a contribution in exchange for a portion of the member’s membership interest.
There are many possibilities to choose from, but members should consider the effect the additional capital contribution language has on the limited liability of the LLC. Some courts have interpreted the additional capital contribution language as requiring the members to pay LLC debt that the LLC cannot pay itself. This would therefore defeat a major benefit utilizing an LLC where members are not individually liable for the debts of the LLC. However, the members may avoid this by stating in the operating agreement that additional capital contributions are never required and the members have no personal liability for the debts of the LLC. But by taking this course of action it may cause problems later if the LLC needs additional capital.
The important takeaway here is to consider and plan for the potential needs of the LLC, and to do so in a way that doesn’t result in unintended consequences for the LLC or its members. An operating agreement is a road map and tool to navigate through difficult challenges and obstacles.
If your have questions about your operating agreement, please contact our attorneys at Morsel Law.