LLCs are the most popular type of business entity due to their flexibility, ease of management, and liability protection. However, many LLCs operate without a formal operating agreement, and even when one exists, it often lacks crucial provisions. An LLC’s operating agreement serves as the backbone of its structure, dictating how the business operates and how key issues are handled. But does your agreement prepare for life’s unexpected twists—such as a member’s divorce, disability, or passing? These events, while uncomfortable to consider, can have significant consequences for the business. Ensuring that your operating agreement covers these contingencies can safeguard the company’s stability and prevent disputes. Let’s explore why these provisions matter and how they can protect both the LLC and its members.
Divorce and LLC Membership
If an LLC member goes through a divorce, their ownership interest could be classified as marital property, which may be subject to division under state law. Without proper safeguards in place, an ex-spouse could end up with an unintended stake in the company. This can create complications, especially if the remaining members do not want an outsider influencing business decisions.
One way to mitigate this risk is through a spousal waiver clause in the operating agreement. This provision requires the member’s spouse to relinquish any claim to LLC ownership in the event of divorce or death. Including such language ensures that business interests remain with the intended parties and prevents disputes over ownership that could disrupt operations.
Planning for Disability and Death
Unexpected health issues or a member’s passing can create uncertainty for an LLC. If a member becomes disabled and can no longer participate in the business, or if their ownership interest is transferred to heirs after their death, the remaining members may face complications regarding voting rights, profit distributions, and overall business control.
To address these challenges, many LLCs include a buyout provision in their operating agreements. This provision outlines how a disabled or deceased member’s ownership interest will be handled, often granting the remaining members or the LLC the right to buy out the departing member’s share. The agreement should establish a clear method for valuing the business, so all parties understand how the buyout will be calculated.
Additionally, some LLCs take out life or disability insurance policies on their members, using the proceeds to fund a buyout. This strategy helps prevent financial strain on the company while ensuring a smooth transition of ownership.
Why This Matters
Without these safeguards, an LLC may face internal disputes, unwanted ownership changes, and financial instability. Addressing these scenarios in the operating agreement provides clarity, protects the business from disruption, and ensures that ownership transitions align with the members’ intentions.
If your LLC’s operating agreement does not include provisions for divorce, disability, or death, now is the time to review and update it. Taking proactive steps today can prevent unnecessary complications and help secure the long-term success of your business.
Would you like guidance on updating your LLC’s operating agreement? Contact us to discuss how to tailor these protections to your company’s needs.
