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8 Stupid Mistakes in Your LLC Operating Agreement - YouTube
Channel: Clint Coons Esq. | Real Estate Asset Protection
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- Hi guys, Clint Coons here
with Anderson Business Advisors,
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and in this video, we
are gonna talk about some
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of the stupid mistakes
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people make when it comes
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to creating their LLC
operating agreements.
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All right.
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Let's get started.
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(upbeat music)
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Okay, so I'm gonna talk about
some mistakes that I see,
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oftentimes, when I review
existing operating agreements
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that people have set up with
either inexperienced attorneys
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that are not familiar with
creating operating agreements
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for real estate investors.
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Or worse yet, you went
on the internet, right?
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You went to Legal, I mean Zoom.com
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and said, "Give me an
operating agreement."
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And you think you're protected.
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This happens all the time.
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People have these operating agreements
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that they're owning real estate under.
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They're operating their business under,
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and they don't know what's in
there, or more importantly,
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they don't know what's missing.
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And as a result of it, this will come up
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when you're involved in a lawsuit,
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and it could come back to bite you.
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Well, I want to give you eight issues
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that I see many times
in operating agreements
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that you should look to avoid
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in putting together your
LLC operating agreement.
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Okay, so what is the first one?
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The first issue I have is
going to be member managed.
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All right?
(marker squeaking)
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We don't want to do member managed.
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If you're not familiar with this,
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when you set up an LLC,
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you have different styles
of running that company.
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It can be either manager
managed or member managed.
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Now the reason I don't
want to do member managed
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is because in a member-managed context,
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all of the members can exercise control.
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So if you want to do
something in the future,
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like gift away part of
it to your children,
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and then you want to sell the property.
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Guess whose permission you
have to get? Your kids'.
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You wanna refi the property.
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You gotta get your kids'
permission to do it.
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Keep that out of there.
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So the other problem with member managed
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is when you file it with
the secretary of state,
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many time the secretary of
states would like to know
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who are the members.
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If you set up a member-managed LLC,
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then they want you to list the members.
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So now you disclose the
fact to the world at large
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that you own this LLC.
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Not a lot of privacy there.
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The other side of the coin
is what is referred to
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as a manager-managed LLC.
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And even though you're gonna be the member
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and the manager, still,
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I like to set them up as manager managed,
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because it tells everyone,
hey, this is a person
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that has control.
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They run the company.
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If you give ownership away later on
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to your children or someone else,
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you're still in control, and
you never lose that control.
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So I would avoid member
manager and opt to go, always,
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with manager-managed
limited liability companies,
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unless you're using one of my strategies
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where we're looking for anonymity.
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Then forget what I just said.
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But when you're setting up an LLC,
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and you're not doing the anonymity side,
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and you can look at my
other videos on that
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with Wyoming limited liability
companies and setting it up,
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that's gonna be a little
different in that context.
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Okay, number two.
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This is a bad one.
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Number two is going to
be forced distributions.
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(marker squeaking)
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Okay, so what does that mean?
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So in a limited-liability company,
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you have the ability, right,
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to distribute money out to yourself.
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That's called a distribution.
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So you have your LLC.
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Let's say here's my LLC right here.
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It's got some money inside of there.
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I'm a member, and I take money out.
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Okay, when I take money out as a member,
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that's called a distribution.
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Now the problem I run into in,
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you'll see on an operating agreements,
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is they have provisions in
there that require the company
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to distribute the profits
on an annual basis
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to its members, or distributed
enough money to its members,
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to cover their tax liability.
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Now that may seem great at the outset
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when you look at that.
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Hey, great. I get money out of my company.
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But remember it's your
company. You control it.
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Why do you have to have an
operating agreement tell you
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what you need to do?
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Why not allow the operating agreement
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to give you discretionary authority
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to make those distributions?
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Here's why it's important.
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Let's assume that you're sued,
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and they get a judgment against you.
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And they file a charging order
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on your limited liability company.
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And you've know all about
charging orders by now,
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if you've been a member
of my channel for a while,
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that you don't have to
distribute any money out,
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creditor doesn't get paid.
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But, oh, wait a minute.
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Your operating agreement, doesn't give you
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that discretion any longer,
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'cause your operating agreement forces you
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to distribute money out of it.
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See what can happen?
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You could have a judgment
entered against you,
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charging order entered against your LLC.
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You sit back and you say,
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"Well, this company is
not making distributions."
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They pull up your operating
agreement and say,
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"See right here?
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It states you gotta
distribute out all the profits
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on an annual basis."
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So that is a trap.
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Do not have any language in there
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that forces you to make distributions.
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Which brings me to my third point in this.
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You wanna make sure that
your operating agreement has
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what's called non-pro rata distributions.
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(marker squeaking)
All right?
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So that is another important clause
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that goes right along with that.
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And with non-pro rata,
what it means is that
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if there's multiple members in your LLC,
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you don't have to make
distributions equally.
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Let's say I created this
limited liability company,
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and I have another partner involved.
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And this partner, here, is
going through a divorce.
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And so that partner doesn't want
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to take any money out right now,
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because it's just gonna
complicate their divorce.
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So they want to keep the
money inside of the company.
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Well, what does that do to me?
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So I need the money. I
want to take the money out.
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Well, if it's pro rata distributions,
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and we have $100,000 in here,
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then you would have to divide it up 50/50.
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50/50 like that.
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So I would get 50K,
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and my partner over here,
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she's gonna get 50K,
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and then possibly that money is gonna go
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to the attorneys, and
get spent, and disappear.
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So if I have non-pro rata distributions,
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it allows me to take my money,
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and I don't have to give
it to my other partner.
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Think if you had kids involved.
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Same scenario here, right?
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You could have a couple of
children involved in your LLC
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at some point in the future,
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just because of they're there
doesn't mean they get money.
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You decide who it gets the
money out of the entity,
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and it doesn't have to be equal.
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So you'd want to create your
entity with non-pro rata.
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And you'll see that in
the distribution clause,
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All right, the fourth issue is going to be
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(marker squeaking)
no charging order language.
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Okay, this is important to
have in your LLC to state
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that in the event a member is under duress
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that your company,
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if a charging order's entered against you,
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that you do not have to
distribute money to them,
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that they cannot take
your interest from you,
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that if a court tries to
award their interests,
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they become an assignee.
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Not having charging order
language in your LLC agreement
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that addresses these
issues can be a problem.
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If a lawsuit develops, and a
judgment's entered against you,
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you may lose your interest,
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or the person that is
awarded your interest,
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a suit can assume control
over your company.
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So you want to make sure
that you're limiting that.
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Which brings me to my next point, five,
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(marker squeaking)
restrictions on transfer.
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Okay, no restrictions on transfer
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is really what we should be writing here.
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You have to make sure that
you have this type of language
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in there that you can restrict
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who can become a member in the LLC.
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So by putting restrictions
in your operating agreement
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to restrict the transferability
of your interests,
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it prohibits or makes it very difficult,
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for a creditor to get your interests.
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But more importantly,
if you're using your LLC
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in the future for estate
planning reasons, and you again,
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bring other people in,
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you know who you're getting involved with.
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The worst part situation you
could possibly find yourself in
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is that that individual
that you're working
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with now transfers their
interest to someone else.
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And now you're in business
with someone you never knew.
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Who wants to be in that situation?
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But if you have restrictions
on transferability
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to stop people from being able
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to just transfer their
interest or anyone at any time,
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then you can be assured that
the members will stay the same,
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unless you agree to the transfer.
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So restrictions on
transfer, really important.
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Number six, okay, improper tax provisions.
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All right?
(marker squeaking)
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Improper tax.
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What does this mean?
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Well, an LLC is a hybrid entity.
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So in a hybrid entity, you can choose
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how you want that entity be taxed.
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It can be taxed as a C
corp, S corp, partnership,
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or disregarded entity.
(hands clapping)
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So many operating agreements are drafted
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as partnerships by default,
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but then the client chooses
to set it up as a C corp,
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or an S corp, or maybe
even a disregarded status,
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so it doesn't match the
operating agreement.
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And so where you can get
into problems is with the IRS
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that you're paying taxes, or
you're treating your entity
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as a corporation, but it says
it needs to be a partnership.
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So that could raise your taxes
on you if you were audited.
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Or if you're involved in a lawsuit,
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someone could say, "Look
it, he has an LLC treated
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as a corporation, but its
operating agreement conflicts,
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and it's treated as a partnership.
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Maybe there's a benefit
there for the creditors."
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So you want to make sure
that the tax provisions
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inside of your company
agreement match the tax election
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that has been made with your
limited liability company.
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All right, number seven, okay.
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(marker squeaking)
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Right to return
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of capital.
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This is an issue,
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when you have a right to return
of capital inside of there.
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What it means is this,
that if I put in $100,000,
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then I'm entitled to get that money back.
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No, we don't want that. Right?
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You may, it sounds great,
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just kinda like the forced distributions.
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You have to distribute the money
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to everybody on an annual basis.
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But think about this for a minute.
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If I'm putting $100,000
into an LLC that I control,
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I can take it back at any time.
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Why do I want my operating
agreement to state
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that I'm have a right
to get that money back?
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Because what that could be
do to you, in the future,
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is that if, again, if you're
involved in a lawsuit,
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judgment's entered against you,
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maybe a creditor now has found a way...
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Maybe they can't take it all,
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but they get a piece of that company,
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because they go back in,
they grab your interest,
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and they say, "Well, we're entitled
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to receive our capital back.
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Distribute our capital back to us."
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And they take it back.
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So you want to ensure that
your operating agreement states
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that there's no right
to return of capital.
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You do not want to have a right
to receive your money back.
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You have that control.
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You can decide if that's ever coming back.
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And the last issue that I see
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that I think's really important
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is no officer
(marker squeaking)
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appointment provision.
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Okay, so when we talk about
limited liability companies,
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we talked about member managed
or manager managed LLCs.
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But guess what? You can
also appoint officers.
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And here's the thing.
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I like having these provisions inside
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of my operating agreements to allow you
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to be a president, secretary, treasurer.
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So you can operate as an
office officer of that company,
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and you don't have to
adopt the label as manager,
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when you're dealing with third parties
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or member when you're dealing with them.
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You just tell them you're a president.
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It gives you apparent
authority, number one,
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so that you have this control.
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And then when you start to build
out an anonymity structure,
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like I've shown you in many of my videos,
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where you have a Wyoming
LLC owning in-state LLCs,
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it can get kinda complicated
for third parties to say,
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"Well, who's really in control here?"
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Well, it's real simple now.
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If you have a provision in
your operating agreement
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that allows you to appoint
yourself as a president,
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appoint yourself as a president.
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And then you can say, "I am in control
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of this company as its president."
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And here's the nice thing about it.
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When you have officer
provisions inside of your LLC,
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you're allowed to appoint
these individuals as officers.
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They don't get listed anywhere
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on the secretary of state's website,
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because that information isn't collected.
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So you can control it
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without anybody knowing
you're in control of it
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if they look at the
secretary of state's website.
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So it gives you some
defacto anonymity there.
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Having officer provisions
gives flexibility.
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Make sure you have that in there.
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Here's eight of them.
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There are so many more
we could go through.
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I don't want to have the time,
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but these are what the eight
key provisions, mistakes,
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that I see in a lot operating agreements
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that you should check
yours for, right now,
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to ensure that you have the
protection you're seeking.
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All right, guys, if you like the channel,
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give me a like on that.
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And if there's any comments about that,
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put some comments down below,
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and I'll get to those relatively shortly
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to make sure you're getting
your questions answered.
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Thanks.
(gentle music)
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