The beginning of the year is an ideal time for business owners to evaluate their business’s past performance and to set future goals. The beginning of the year is also an opportune time for business owners to examine their business’s governing documents.
A popular form of business entity is the limited liability company (“LLC”), which is a flexible type of entity with relatively few formal governing rules. The primary governing documents of a Texas limited liability company are (1) the certificate of formation, which is filed with the Secretary of State, and (2) the company agreement, which is agreed to among the owners (called “members”) of the LLC. While the certificate of formation typically includes very basic information about the LLC, the company agreement often includes many detailed governing rules. This blog post addresses some of the most important topics that are often included in an LLC’s company agreement.
It is essential that the company agreement define the relative rights of members. In many instances, all LLC members will be treated equally with respect to their right to participate in the LLC’s governance. However, members might desire to create separate classes of membership interests with different governing rights. Perhaps LLC members desire to provide an “upside” incentive to one or more key employees of the LLC without granting those employees governance rights. In this instance, the company agreement could provide for a nonvoting class of membership interests intended to qualify as a profits interest. If there will be many members, it may be desirable to create several types of membership interests with varying degrees of rights and responsibilities.
The company agreement should also provide clear rules about how the LLC is to be governed. LLCs may be either managed by members or managers. Whether a Texas LLC is member-manager or manager-managed is indicated in the certificate of formation, but the company agreement ordinarily provides details about these governing rules.
A member-managed LLC company agreement could allow for the appointment of a managing member with a wide degree of authority to make decisions for the LLC. Alternatively, each member could be provided with an equal vote with respect to LLC decisions, and decisions on certain matters could require, for example, a majority (or perhaps) vote of the members.
In a manager-managed LLC, the managers are primarily responsible for operating the LLC, but the company agreement can dictate the amount of authority possessed by the managers. A company agreement could provide that certain important decisions require the consent of the managers and the members. The company agreement can establish, among other things, the number of managers, the term of managers, the rules for removing and replacing managers, and whether a manager must also be a member of the LLC.
Transfer restrictions often feature prominently in company agreements. Business owners are ordinarily judicious in their selection of co-owners and, as a result, company agreements usually contain strong transfer restrictions. Oftentimes the transfer of membership interests will require the consent of all of the members. Or, the members could leave the decision of whether to approve the transfer of membership interests to the discretion of the managers or certain members. Also, the company agreement could provide the members with rights of first refusal before any member is permitted to transfer membership interests to a third party. In LLCs with only two members, a push-pull provision is often included to account for the possibility that a dispute between the members may arise that makes it impossible for the parties to carry on as members of the same LLC. In this instance, a push-pull provision essentially provides one member to set the terms of sale of the membership interests, and the other member then must decide whether to sell all of the member’s membership interests or to purchase all of the membership interests of the other member. The transfer restrictions should be tailored to conform to the members’ preferences.
This blog post contains a discussion of just some of the most important topics typically covered in a company agreement. It would be best to review a company agreement with the help of an experienced business attorney.