Suppose you’re starting a business and forming a limited liability company (LLC) in South Dakota. In that case, you’re not required to have an operating agreement, but it’s a good idea to have one in your records.
An operating agreement is significant if your LLC has more than one owner, or member, as it establishes ownership shares, profit and loss distributions, and member roles and responsibilities.
Why You Need an Operating Agreement
A smartly drafted operating agreement can help you in many situations, such as when your LLC merges with another business or a member is no longer capable of working.
The operating agreement establishes each member’s ownership share in the LLC, profit and loss distribution percentages, and how proceeds will be divided if the business is sold. An operating agreement also defines how decisions and member disputes will be resolved.
It also defines each member’s role and responsibilities and how the LLC is managed, clarifying who oversees which aspects of LLC operations.
Without an operating agreement, South Dakota laws will apply by default, and disputes may have to be settled in court, which can have serious negative consequences for the business.
What Should the South Dakota Operating Agreement Include?
The South Dakota Operating Agreement details the internal conduct of an LLC within the state. It’s imperative to grasp its main components for smooth functioning and anticipating potential issues.
- Each member’s rights and responsibilities: Clearly delineate the obligations, duties, and rights of each member. In South Dakota, members have broad discretion to define their rights, but they should be clearly documented.
- Capital contribution requirements for each member: Detail the expected initial contributions (monetary, property, or services) from each member and possible future calls for capital.
- Procedures for adding and removing members: South Dakota law allows flexibility; therefore, your agreement should explicitly state the process and criteria for adding or removing members.
- What happens when a member sells their interest, becomes disabled, or dies: Incorporate provisions on buyout rights, continuation of the LLC, and how the member’s heirs or representatives will be treated.
- Conditions under which a member might become bankrupt or insolvent: Define the implications of a member’s bankruptcy, ensuring the LLC’s stability.
Management and Voting:
- Management structure and roles of members: Determine if the LLC will be member-managed or manager-managed. Clarify roles, powers, and responsibilities accordingly.
- Voting rights of each member: While it might default to proportional ownership, you can structure different voting rights based on other criteria.
- Rules for meetings and voting: Detail the frequency of meetings, notice requirements, and quorum. Specify the decision-making process.
- Rules for managing potential conflicts of interest among members: Set standards for transparency, duty of loyalty, and procedures for recusal when conflicts arise.
- Allocation of profits, losses, and distributions: Specify how these will be divided among members. By default, it may be proportional to capital contributions, but you can define other methods.
- Provision for periodic financial audits or reviews: Ensure transparency by stipulating regular financial reviews or audits.
- Tax treatment of the LLC: Typically, LLCs are treated as pass-through entities, but members can choose alternative tax treatments.
Changes and Amendments:
- Process for amending the operating agreement: Detail the procedure, ensuring clarity. Consider requiring a supermajority for major amendments.
- Guidelines for company management during transition events: Define strategies for business continuity during unforeseen events or transitions.
- Conditions under which the LLC might be sold or merged: Offer clarity on how major business decisions are made and executed.
Disputes, Legalities, and Policies:
- Clauses for dispute resolution or mediation: Highlight the steps for resolving internal disputes, potentially saving time and money over litigation.
- Guidelines for non-compete and confidentiality agreements: Establish boundaries to protect the LLC’s interests while ensuring they are enforceable within South Dakota’s standards.
- Provision for indemnification and limitation of liability: Define protections for members acting on the LLC’s behalf, promoting confidence in their roles.
Record Keeping and Communication:
- Details about record keeping requirements: Outline what records must be maintained, aligning with South Dakota’s requirements and enhancing transparency.
- Guidelines for how company-related decisions will be documented or communicated: Ensure consistency in communication and decision documentation.
Company Information and Dissolution:
- Description of the business’s purpose and activities: Though not strictly necessary, providing clarity can aid in aligning member objectives and third-party interactions.
- Identification of the registered agent and office: South Dakota mandates this information for all LLCs. Detail your LLC’s primary contact for legal matters.
- Procedures for dissolving the LLC: Adhere to South Dakota’s statutory requirements while detailing the process for member agreement.
- Procedures for winding down or liquidating the company’s assets: Define how assets and liabilities are addressed upon dissolution, ensuring fairness and adherence to state laws.
How to Draft a South Dakota Operating Agreement
You can find operating agreement templates online from services like ZenBusiness, which will ensure the standard legal language and allow you to fill in the blanks. You’ll probably be able to find free templates online as well, but it’s advisable not to use those as they may include errors.
Consider having an attorney draw up your operating agreement if your business has multiple members. An attorney will ensure that all bases are covered and all member’s rights are protected. They can also include language that is specific to South Dakota laws.
This could cost anywhere from $500 to $2,500, but it could save you much more.
Articles of Organization vs. Operating Agreement
The operating agreement should not be confused with your LLC’s articles of organization. The articles of organization officially form your LLC with the state and include no information about member roles or financial interests.
Also, the articles of organization are filed with the state and part of the public record, while an operating agreement is kept in your LLC’s records and referred to as needed.
Though you can include provisions related to your operating agreement when you file your articles of organization, if the provisions contradict your operating agreement, your operating agreement will control members of the LLC. Likewise, your articles of organization will control parties outside of the LLC.
Keep Your South Dakota Operating Agreement Up to Date
It’s a good idea to review your operating agreement periodically. Circumstances change, and the safest approach is to ensure your operating agreement is entirely up to date. Generally, your operating agreement will state that members have to vote to approve amendments to the operating agreement.
Don’t Skip the Operating Agreement
You’re not required to have an operating agreement in South Dakota, but the wise entrepreneur would never do business without one. It’s a document that could be critical to the future of your business. You may think a dispute will never arise, but times and people change.
You don’t want to end up in a bitter court battle because you pushed off creating an operating agreement. It’s a document that will protect the rights and interests of your LLC members and ensure smooth, continued operations in the event of any unexpected hurdles or pitfalls.
Does an LLC operating agreement need to be notarized in South Dakota?
No, operating agreements do not have to be notarized. They are not filed with the state, just kept in your records.
What happens if a South Dakota LLC does not have an operating agreement?
South Dakota’s default rules for LLCs will apply, but in cases of dispute, the law may be vague, and your members could end up in court.