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