Why You Need an Operating Agreement for Your Texas LLC
When you decide to start your own business, the first step on your road to success is determining the best entity structure. An LLC in Texas provides multiple benefits to both sole owners and multi-member LLCs. Though not required, creating an operating agreement for your Texas LLC is recommended to assist in your LLC growth.
What Is an LLC?
An LLC represents a business structure providing limited protection for the personal liability of the sole owner or multiple members of the LLC, in addition to tax advantages. Additionally, LLCs are not subject to detailed and often complicated filing and reporting requirements of corporations. The increasing popularity of LLCs may be due to either of these characteristics.
Structure of an LLC
An LLC may be managed by members or managed by managers.
Member-managed LLCs exemplify an LLC structure where the members organizing the LLC vote and decide on matters concerning the LLC. Members in this structure vote on significant issues concerning the LLC and everyday operational issues.
With manger-managed LLCs, more passive investors do not make day-to-day decisions regarding the LLC. Members hire a manager to make these types of decisions. However, significant decisions require the majority vote of the LLC members. Your Texas LLC operating agreement will dictate whether members must provide a simple majority, supermajority or unanimous consent in these situations.
Members make up the owners of a Texas LLC. While an LLC may have a sole owner, typically, a Texas LLC comprises multiple individuals, corporations, or even other LLCs. LLCs enjoy different tax treatment than corporations. Taxation of each member of an LLC acts on a pass-through basis. This allows LLC members to avoid the double taxation experienced by shareholders in corporations.
LLC Operating Agreements in Texas
No requirement exists under Texas law for a Texas LLC to create an operating agreement. However, it is recommended. Both sole owners and multi-members benefit from a Texas LLC operating agreement.
Operating agreements for an LLC in Texas provide essential information such as the LLC’s financial structure, organization, company rules, and regulations. Texas LLCs with multiple members should sign an operating agreement, as it limits the possibility of disputes or misunderstanding among the members. Additionally, operating agreements can govern the following:
- Profit-sharing among members,
- Decision-making responsibilities, and
- Buy-sell terms.
Hashing out these potential issues before they arise saves on legal fees and disagreements that may threaten the LLC’s future.
Critical Sections of an Operating Agreement in Texas
Although you can draft your Texas LLC agreement as you see fit, there are multiple recommended key sections to include.
The Texas operating agreement’s organization section provides initial information for the LLC, such as creation date, initial members, and ownership structure. Typically this section also outlines the ownership percentage interests of all the founding members.
Information about the management of the LLC reduces the risk of disagreements between members in the future. When issues arise, this section of the operating agreement directs how members vote on Texas LLC decisions.
Capital details how the LLC receives initial funding. If founding members provide the initial funding, this may affect ownership percentages in the LLC.
LLC members share in the profits and losses of an LLC. However, the operating agreement for the Texas LLC directs the distribution of profits and losses.
Changes in Membership
Changes in membership of a Texas LLC commonly occur over the years. Members may pass away, or members may wish to move on to other ventures. This section of the Texas LLC operating agreements provides direction for adding and removing members.
Although you may never imagine dissolving your LLC, it’s essential to prepare for the possibility. Therefore, all LLC operating agreements in Texas should include dissolution provisions. These provisions additionally outline winding up the LLC and other needs of the company.
Types of LLCs
Multiple forms of LLCs exist in Texas and offer benefits for different types of businesses. Discuss your business plan with a qualified business attorney in Texas to determine the best LLC type for your business.
Traditional LLCs essentially represent all LLCs not identified as series LLCs, professional LLCs, S-Corp, or C-Corp LLCs.
Series LLCs permit investors to hold assets and liabilities within series LLCs essentially operating as sub-businesses. These sub-businesses behave as separate entities. However, the law does not recognize them as separate entities. Therefore, the law treats the entire series LLC as a single entity. It pays one filing fee to the Texas Secretary of State and files one franchise tax report under a single Employer Identification Number (EIN). One of the series LLC’s main features is the ability for the series LLC to pass through all profits and losses and shield liability while separating assets and liabilities into to different sub-businesses within the series.
Professional LLC or PLLC
Professional LLCs represents an entity structure available only to a select group of individuals. These individuals must be required to hold a Texas license for their line of work. For example, doctors, attorneys, and dentists all need Texas licenses to conduct their business. PLLCs can be owned and operated only by these licensed professionals.
An S-Corp LLC elects taxation as an S-Corp. To elect taxation as an S-Corp, you must file Form 2553 with the IRS. S-Corp taxation offers benefits similar to an LLC by allowing income to pass through the LLC to the members. The S-Corp election must be made more than two months and 15 days after the beginning of the tax year when the election is to go into effect.
A C-Corp LLC elects taxation as a C-Corp. To elect C-Corp status as an LLC, you must file Form 8832 with the IRS. When filing Form 8832, you must designate an effective date. The election may not take more than 75 days before the election is filed but cannot take effect later than 12 months after the filing.
Texas LLC Procedure
To form a Texas LLC, you must first determine the name of your LLC. It’s recommended to conduct a name search of your LLC ensuring availability of the name.
Secondly, upon determining your name, you must file a Certificate of Formation with the Texas Secretary of State. Although you never file an operating agreement for the LLC in Texas, it’s still always recommended to create one for your LLC.
Formation of the LLC occurs after the Texas Secretary of State accepts the Certificate of Formation. At that time, the LLC members should hold their first organizational meeting of the LLC to meet and approve the operating agreement. Additionally, you must acquire an Employer Identification Number (EIN) for your LLC. The IRS issues this number to identify your LLC for tax purposes and reporting.
Wood Edwards LLP is a boutique law firm based in Dallas. With a renowned reputation for big-firm talent and small-firm efficiency, our attorneys represent clients in all types of business matters, including LLC formation. You never want to start a business on the wrong foot. The attorneys at Woods Edwards LLP understand the importance of choosing the right business entity and preparing for all possible events that may affect your venture’s future. Your business is your livelihood. We are here to support and protect your interests as you embark on this new journey. Contact our office today to discuss your Texas LLC operating agreement.