A limited liability company (LLC) is a business structure. In addition to limiting the liability of its owners, which are called members, the primary advantage of an LLC is that it is a pass-through entity. Pass-through entities, which include LLCs, Limited Partnerships and S corporations taxed as partnerships, are not subject to income tax. Instead, the individual owners are responsible for taxes due.
This can be attractive for private equity investments if the intention is to make distributions throughout the hold period. In contrast, with a corporation, profits are first taxed at the corporate level and then taxed a second time when those profits are distributed to shareholders.
LLCs are popular in private equity transactions because they are easy to establish and because they offer a lot of flexibility for different equity structures.
What is an LLC Operating Agreement?
The LLC operating agreement outlines in detail how the members will interact to guide the financial and operational objectives of the LLC. LLC operating agreements can vary from one transaction to the next, but most will cover the topics outlined below.
- Organization: The basic information describing how the entity is structured. This section includes details that cover the name of the entity and its purpose.
- Membership Interests: This covers the member’s ownership interests. If the structure calls for different classes of membership interests, they will be described in this section. This section will also reference an exhibit listing all of the members and their respective ownership on the date of formation.
- Management: This covers the management of the LLC.
- Indemnification: The LLC will agree to indemnify any member or manager for liabilities and losses incurred related to the LLC.
- Taxes: This covers tax reporting requirements and tax elections.
- Books and Records: This details the financial reporting requirements of the LLC and the maintenance of books and records.
- Allocations and Distributions: This covers distributions of cash and the allocations of profits and loss to members.
- Transfers: This informs members of the limitations surrounding transfers of membership interests.
- Dissolution and Liquidation: This covers the process and approval required for any dissolution or liquidation proceeding.
- Provisions Relating to Members: This covers the rights and obligations of the members of the LLC.
For a private equity control transaction, the LLC operating agreement will typically run between 50 or more pages in length.