When the company has more than one owner

An LLC’s operating agreement often receives the most attention when the company is formed and the least attention while the business is growing. Owners may sign an initial document, open a bank account, and concentrate on serving customers. Years later, they discover that the agreement does not address the decisions now facing the company: admitting an investor, funding an expansion, replacing a manager, or buying out an owner who wants to leave.

A lawyer’s review is particularly useful before those decisions become commitments. The agreement should explain how the owners’ relationship works today and provide workable procedures for foreseeable changes. A document that was adequate for one owner operating a small business may require substantial revisions once ownership, financing, or management becomes more complicated.

For California LLCs, the operating agreement occupies a central statutory role. Corporations Code section 17701.10 generally allows it to govern member relationships, manager rights and duties, company activities, and amendment procedures, subject to statutory limitations. Where the agreement does not address one of those matters, the statute supplies the governing rule. Silence therefore has legal consequences even when the owners assume they have an informal understanding. Cal. Corp. Code § 17701.10(a)–(b).

The first useful time for review is before multiple owners begin contributing money or work. At that stage, counsel can help distinguish ownership from the obligations associated with ownership. An agreement should identify each member’s contribution, whether additional contributions may be required, and how the company will treat advances made later. A payment described casually as “putting more money into the business” could represent a loan, additional capital, or a payment carrying no additional ownership rights. The records should make that distinction clear.

Consider an LLC owned by two people. One provides most of the initial funding, while the other manages daily operations. Both may describe the arrangement as an equal partnership, but that phrase leaves several questions unanswered. Do they have equal voting rights? Will the funding member recover the initial investment before other distributions? Is the operating member entitled to compensation? What happens if that person stops working? A review can turn those expectations into specific provisions before the answers become contested.

Management, votes and authority

Management structure is another reason to obtain advice early. California law treats an LLC as member-managed unless its articles contain the statement required for manager management; the articles must also say if a manager-managed LLC will have only one manager. The statutory rules distinguish ordinary business decisions from matters requiring broader approval. Counsel should examine the articles and operating agreement together so that the public filing, internal authority, and intended management structure are consistent. Cal. Corp. Code § 17704.07(a)–(c); id. § 17702.01(b)(5)–(6).

Ownership percentages should not be assumed to answer every voting question. California’s member-managed rules speak of equal management and voting rights, but the same statute permits the articles or a written operating agreement to allocate votes by financial interest, class, head count, or another basis. If neither document addresses voting, votes are proportional to members’ interests in current profits, not automatically equal per person or proportional to initial capital contributed. Thus, an owner who supplied 70 percent of the capital cannot assume that contribution alone controls every decision. Counsel should identify current-profit interests and draft the voting arrangement the members intend. Cal. Corp. Code § 17704.07(b), (r).

A review should also distinguish internal approval from the practical authority to act. The owners may agree that borrowing requires approval, but employees, lenders, and vendors still need to know who can negotiate and execute documents. Spending limits, approved budgets, banking authority, and procedures for documenting consent can make the governance provisions usable. An agreement requiring approval for every minor purchase may impede operations, while unrestricted authority may expose the company to commitments the owners never anticipated.

The admission of a new investor is another important review point. New capital can change economic rights, voting power, reporting obligations, and expectations about an eventual sale. Before offering an ownership interest, the company should evaluate the existing agreement’s admission and amendment procedures. Counsel should also consider whether the proposed investment requires a separate securities-law analysis. An amended operating agreement is one part of documenting an investment; it does not resolve every legal issue associated with raising capital.

Existing members should understand how the new investment affects them. The revised arrangement may create preferred distributions, special approval rights, or different treatment upon liquidation. A minority investment can carry significant control rights if the investor must approve budgets, financing, management changes, or a sale. The review should assess the complete package of rights rather than focus only on the investor’s percentage.

New investors and capital contributions

Financial provisions deserve attention whenever the company’s funding needs change. An agreement may permit capital calls without explaining what happens if a member cannot participate. Possible negotiated consequences include loans, dilution, or a buyout process, but each requires careful drafting and financial analysis. The members should understand who can initiate a funding request, what information must accompany it, and whether the response period is realistic.

Distribution provisions should likewise reflect the business’s circumstances. Owners may expect regular cash payments while managers anticipate retaining earnings for expansion. The agreement can establish a process for evaluating reserves, anticipated expenses, and distributions. For an LLC taxed as a partnership, counsel and the company’s tax adviser should also evaluate whether a tax-distribution provision is appropriate and how it interacts with available cash, financing restrictions, and other payment priorities.

Related-party dealings are another trigger for review. An owner may lease property to the company, provide services through another entity, or pursue opportunities in the same market. In a member-managed LLC, California Corporations Code section 17704.09 identifies members’ duties of loyalty and care and the obligation of good faith and fair dealing; in a manager-managed LLC, the fiduciary-duty allocation differs. Section 17701.10 allows specified modifications but limits elimination of loyalty, unreasonable reduction of care, and elimination of the obligation of good faith and fair dealing; modifications of specified fiduciary duties require a written operating agreement and informed member consent. A broad statement that members may pursue outside interests therefore deserves careful legal review. Cal. Corp. Code § 17704.09; id. § 17701.10(c), (e)–(g).

The practical objective is to establish a workable disclosure and approval process. Members should know when an outside transaction must be disclosed, who evaluates it, and how approval is recorded. For example, if the company rents a warehouse from a member, the agreement can address how the rental terms are reviewed and who approves later increases. Clear procedures help the business manage recurring conflicts without reopening the entire ownership relationship each time.

Information rights also matter, particularly when some owners are not involved in daily operations. California law gives members and certain other interest holders specified information and inspection rights subject to conditions such as a qualifying request and a purpose reasonably related to their interests. Any waiver of the rights provided by section 17704.10 is unenforceable. An operating agreement should support those rights while establishing useful reporting practices, such as periodic financial statements and a designated contact for requests. Cal. Corp. Code § 17704.10(a)–(b), (h).

Conflicts, information rights and transfers

A proposed transfer is another occasion for review. California law distinguishes transferring an economic interest from obtaining the full rights of a member. Subject to statutory qualifications, a transfer alone does not grant the recipient voting or management rights; a recipient may instead receive the distributions attached to the transferred interest. A transfer that violates an operating-agreement restriction is ineffective against a recipient with notice of that restriction. Owners considering a sale, gift, or estate-planning transfer should determine both what may be transferred and, separately, what the agreement and law require for the recipient to become a member. Cal. Corp. Code § 17705.02(a)–(b), (f).

Exit planning should address more than permission to transfer. A buyout provision needs a trigger, a valuation method, a payment process, and a clear identification of the purchaser. An annual agreed value may become unreliable if the members stop updating it. An appraisal process may create disagreement if the agreement does not specify assumptions about debt, cash, discounts, or the valuation date. Counsel should test how the provision would operate under an actual departure scenario.

Leaving management should also be distinguished from surrendering economic rights. On dissociation, California law ends a member’s voting and management participation rights; subject to specified provisions, the former member holds an existing transferable interest solely as a transferee. Dissociation itself does not discharge obligations to the company or other members incurred while the person was a member, and this statute does not create an automatic buyout or payment date. A negotiated buyout therefore needs provisions explaining when a purchase obligation arises and how it will be funded. Cal. Corp. Code § 17706.03.

Deadlock deserves attention before relations deteriorate. Two equal owners may need escalation procedures, mediation, or a carefully designed purchase mechanism. A forced buy-sell procedure can have uneven effects when one owner has substantially greater access to financing. California permits judicial dissolution on specified grounds, including management deadlock or internal dissension. In a judicial-dissolution suit, the other members may avoid dissolution by purchasing the moving members’ interests for cash at fair market value under the statutory procedure; that is not a general, automatic buyout whenever owners disagree. Contractual planning should account for that framework. Cal. Corp. Code § 17707.03(a)–(c).

Businesses should therefore revisit an operating agreement when ownership, management, funding, or exit expectations materially change. A useful review tests concrete situations: a member cannot contribute additional money, an investor requests veto rights, a manager departs, or an owner receives a purchase offer. The agreement serves the business best when its procedures can be followed under those conditions and its provisions remain consistent with the company’s actual records and operations.

For transaction-specific guidance, see Alex Nahai Law’s related legal services. Legal advice depends on the documents and circumstances of each matter.

This article provides general information, not legal advice, and does not establish an attorney-client relationship.