If you’re starting a business that will include partners, incorporate an LLC and set up an operating agreement. That was the message that cannabis attorney Benjamin Sobczak shared with members and guests at Women Grow-Southeast Michigan’s November 2 monthly meeting.
And do it upfront, before problems arise:
In the beginning, everyone is happy and hopeful and excited about the future, so it will be easier to agree on key terms of the operating agreement. Thereafter, when problems do arise, they will be easy to neutralize within that agreed-upon protocol; and the quicker problems are solved, the less expensive they end up being. Alternatively, if the partners cannot agree on terms at that early stage, the business relationship was bound to fail and they get to learn that fact sooner rather than later.
While a sole owner or manager may feel less motivated to create an operating agreement, even they would be advised to have one, he continues:
Most single-member LLC’s are incorporated for liability limiting and tax purposes. To best ensure both of those objectives are achieved, erring on the side of formality is advisable. Accordingly, even in a single-member setting, a short and plain operating agreement is preferable.
An operating agreement is the “internal constitution” of an LLC, Sobczak explains. It should address, at a minimum, the following subjects:
- Formation, term, and purpose of the company;
- Members’ ownership interests, voting rights, and capitalization obligations;
- Allocation of profits, losses, and distributions from the company to the members;
- Management of the company and the respective duties and powers of managing members/managers;
- Transfer of a member’s ownership interests, whether voluntarily or involuntarily; and
- Dissolution and termination of the company.
The operating agreement, in other words, is” the prenuptial agreement for a business.”
The owners of an LLC would be the “parties” to its operating agreement. If the LLC is to be managed by a non-owner manager rather than the owners themselves, those persons’ rights and duties would be addressed in the operating agreement, but they would not be signatories to the document itself as they would not have an ownership interest in the entity.
Hiring an Attorney
Sobczak encourages business owners to seek legal help as soon as the new business endeavor has been conceptualized, the owners and investors are known, and each person’s general role in the business has been determined, but before overt steps toward the new business have been taken.
For instance, do not purchase real estate, sign transactional contacts with third parties, or accept investor funds until after you’ve contacted a lawyer, formed your corporate entity, and finalized your operating agreement.
Or hire the attorney to help you determine your own best business structure:
There are many factors including the size and anticipated sophistication of the business, the preferred tax treatment of the owners, and potential regulatory requirements in the specific industry or industries in which the entity will operate. A qualified attorney should be able to explain the reasons “why” a given structure is most advisable.
He strongly advises business persons who are not lawyers themselves do not write their own operating agreements. Find an attorney with prior experience forming corporate entities and drafting their governing documents.
The attorney should insist on meeting with all of the founding members to determine their specific needs and concerns. That tells you that the operating agreement will be a custom product, rather than a one-size-fits-all document.
The cost to hire a qualified attorney can range from as low as $2,000 to upwards of $10,000, depending on the complexity of the agreement.
Becoming a Cannabis Legal “Expert”
Sobczak, a partner at the national law firm of Dickinson Wright, is hesitant to consider himself an expert in what he considers the exciting and intellectually stimulating area of cannabis legal practice.
However, he concedes that his understanding of the constitutional principle of federalism; regulatory and municipal law; intellectual property law; commercial/business law (contracts, real property, insurance, corporate formation); and the United States banking and a financial system made the industry a “natural fit” for his legal practice:
These are all subjects I’ve dealt with previously in my commercial litigation practice, but I do not believe it is wise to consider one’s self an “expert” in anything. Rather, I study this subject every day because of the energy in the industry and the speed with which the landscape changes make the undertaking more of a passion than a professional obligation.
Ken Wachsberger, editor of Bloom Blog, is an author, editor, and book coach, and the founder of Azenphony Press. He is the author of the upcoming Ken Wachsberger’s Puns and Word Plays for the Job Seeker.