- 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)
