How a Family Business Can Set Up Its LLC Operating Agreement
A Delaware LLC can be very flexible when it comes to preserving ownership in the family business you've worked so hard to create.
In fact, an LLC has the potential to preserve ownership for future decades. In an LLC, the members are free to organize the LLC in whatever manner they choose.
Members possess near-total freedom to define the relationship among the members and the terms governing the operation of the entity. The fundamental terms of an LLC’s ownership, operation and management are set forth in its LLC Operating Agreement.
The LLC Operating Agreement not only governs terms such as sharing of income and liabilities, it also sets forth the terms governing the liquidation of the entity and the replacement of LLC members.
An LLC does not have a fixed life term, thus it can remain in existence even after the death of one or more members. A carefully drafted LLC Operating Agreement can help to ensure a smooth transition of control after the death of a key member, making the LLC an excellent option for preserving ownership in a family business.
The LLC Operating Agreement allows control over the LLC and its assets, allowing both to be passed along to surviving family members.
Get a multi-member LLC Operating Agreement template.
Setting Up an LLC Operating Agreement for a Family Business
Here's how you might choose to set it up:
- The initial members, who are often the founder(s), form and file the LLC and appoint themselves as Class A members within the LLC's Operating Agreement. These Class A members possess all rights and responsibilities for managing the assets/ownership of the LLC.
- The Class B members are tyipcally the offspring of the founders; these family members initially have no responsibility or rights in the LLC. When all the Class A members have passed, these Class B members become the Class A members, which then grants them all the rights and privileges associated with Class A member status.
- The Class C members are a dormant class. Class C members possess no responsibility or rights in the LLC until the passing of both the Class A and Class B members. New classes of member interests can be established at any time, so the Class B or Class C members can, when they ultimately obtain control over the LLC, create additional classes to continue the chain of ownership and control over the LLC for future generations.
It is important to remember that an LLC Operating Agreement is not filed or otherwise disclosed to the state of Delaware or the Delaware Division of Corporations, nor is it part of any public record.
Thus, you can maintain the confidentiality of family affairs in perpetuity if you'd like.
This is just one way to structure a Delaware LLC in order to pass a family business from one generation to another.
Please remember to consult with your estate tax advisor when you set up an LLC for succession planning.
If you'd like to form an LLC or you have questions about an LLC Operating Agreement, please feel free to contact us by phone at 800-345-2677 or by email.
Next: 7 Key Items for Your Operating Agreement
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There are 4 comments left for How a Family Business Can Set Up Its LLC Operating Agreement
JORGE SCHNEIDER said: Tuesday, September 1, 2020Does Class B Members receive a K1 from the LLC with the obligation of submit taxes. Thanks
HBS Staff replied: Wednesday, September 2, 2020Traditionally, LLC members who receive a percent of the company's income will receive a K1. However, because LLCs are extremely flexible in how they are set up, including member classes, we recommend consulting a tax professional or attorney about your specific situation if you have questions.
Rob Ross said: Sunday, January 15, 2017With respect to forming a Delaware LLC, what must be done to set up the structure between members as a joint tenancy so as to avoid the issues of probate if one of the member passes away?
HBS Staff replied: Tuesday, January 17, 2017Traditionally, this is handled within the LLC Operating Agreement. LLCs are generally filed in Delaware without listing the names of the members with the state. This means changes in ownership can generally just be handled internally. The operations and management of the LLC are governed by a written agreement among its owners that is not required to be publicly filed or disclosed to the Delaware Division of Corporations.
As a result, an LLC allows secure anonymity and the ability to create a customized management structure, which prescribes the economic relationship among owners. The Operating Agreement can be written in any language and is not required to be translated into English.
The Delaware LLC statute allows parties to define their business relationship in a written agreement as they so desire. This is called "freedom of contract." Delaware law provides rules only for those matters on which the parties have failed to agree. The stated policy of the Delaware LLC law is to give maximum effect to the principle of "freedom of contract" and to the enforceability of LLC agreements. The contractual flexibility offered by the Delaware Act is unmatched by any other LLC statute.
Feel free to call us with any questions. We are happy to help. 1-800-345-2677.
Rose Diaz said: Monday, March 14, 2016In regard to passing an LLC on to offspring Class B, would they Class B acquire debt if the business is in the hole when the primary Class A member passes away? Just Curious.
HBS Staff replied: Tuesday, March 15, 2016This is a tough question and the answer would very much depend on the particular situation. The solution might be spelled out in the LLC's Operating Agreement, and if it weren't, the Class B members would likely consult an attorney. If you have further questions, please feel fee to call our expert customer support representatives at 1-800-345-2677.
Rose Diaz said: Monday, March 14, 2016In regard to passing an LLC on to offspring Class B, would they Class B acquire debt if the business is in the hole when the primary Class A member passes away? Just Curious.