Understanding Operating Agreements: The Three-Legged Stool for LLCs
- Chris Johnsen
- Jul 3
- 6 min read
Every successful LLC needs operating agreements as its foundational base. Our law firm Johnsen Law provides clients with operating agreement guidance through its "three-legged stool" framework.
This framework protects your business from disputes while maintaining smooth LLC operations and ensuring complete protection for your enterprise.
The following section explains the three fundamental components of LLC operating agreements which Texas LLCs need to consider.
Operation and Control: Who Runs the Show?
Operation and control serve as the foundation of the first stool leg. The fundamental operational structure of your LLC is explained through this section of your operating agreement. Texas LLC operators need to determine if their business should function with member management or through appointed managers during the formation process. A member-managed LLC operates similarly to traditional partnerships because all members get involved in everyday business decisions. Small teams with members who want daily operational involvement find the member-managed system to be their most suitable choice. A manager-managed LLC selects one person who serves as the manager to lead daily operations while members maintain a director-level role for high-level decision-making responsibilities. Large businesses along with organizations requiring a single executive leader find this management structure particularly beneficial.
The choice between these management structures determines how the business will operate and its overall legal exposure. Every member in a Texas LLC with member management obtains fiduciary status that enables them to make binding decisions for the company. The manager-managed structure provides operational power to fewer individuals which reduces risk for investors who are passive or have minority stakes. The established operational authority becomes essential when banks and investors along with third parties need to understand who holds decision-making power.
The operational control system requires specific rules regarding voting rights as well as procedures for making decisions. LLCs have two main voting models: one-person-one-vote and percentage-interest voting. The creation of different membership classes allows businesses to establish flexible participation rules for their members. Establishing rules at the beginning will prevent misunderstandings and create effective governance for decisions about capital spending, staffing and organizational direction.
Texas LLCs grant businesses the freedom to create customized operating agreements which fulfill their specific organizational requirements. The Texas Business Organizations Code grants members complete freedom to establish any organizational structure they mutually agree on. The flexible operational structures of LLCs let business owners establish their preferred company functioning principles which transforms the agreement from a legal document into an operational strategy.
Transfer Restrictions: Protecting Your Partnership
The second leg of the stool is transfer restrictions, which define who can become an owner of the LLC and under what circumstances. The specific provisions become essential for companies with limited ownership because members seek to maintain working relationships with each other rather than bring in unfamiliar outside parties. When no transfer restrictions are present owners maintain the ability to pass their interests to anyone including their family members and business rivals which results in changes to the company's path and operational direction.
The group achieves protection through ownership restrictions which maintain control within trusted members. The most successful transfer restriction method requires all current members to provide unanimous agreement before any ownership transfer can occur. All present members need to provide their approval for any ownership interest transfer within the company. The LLC or other members gain the right to acquire that interest before it passes to a different party according to defined transfer procedures.
An essential element in the business is developing a buyout method. The agreement must describe methods to value departing interests and payment methods when members pass away or wish to exit the business. The agreement should allow members to select between a single payment amount and an interest-bearing promissory note with payment terms. All involved parties receive predictable financial treatment through this system. The establishment of a well-defined buyout provision stops financial problems and shields remaining members from unexpected financial duties.
The LLC operating agreement transfer restrictions require customization to fit the needs of your particular business scenario. A custom agreement protects your business stability and ownership stability for family businesses and real estate investment groups and startup companies with outside investors. This section provides essential protection for Texas LLCs which want to safeguard their future direction through defined and enforceable transfer rules.
Restrictive Covenants: Keeping the Partnership Together
The third leg of the stool is restrictive covenants. Legal provisions that form part of the business structure function to stop disputes and shield the business from damaging conduct from active and former members. Three key restrictive covenants commonly used in business include confidentiality agreements which safeguard trade secrets and intellectual property along with sensitive business information from disclosure or misuse. The protection of your competitive advantage depends on these measures.
Non-compete agreements represent a crucial form of restrictive covenant. Members agree to refrain from establishing or participating in rival businesses throughout a specified time frame and within a specified geographic region. Your LLC stays protected from losing clients and resources as well as trade secrets to a business that operates directly against it. A non-solicitation agreement functions similarly to prevent departing members from stealing clients and vendors and employees when they leave the company. An LLC suffers severe damage when an exiting member utilizes their inside knowledge to steal essential business connections because these protective measures are absent.
The implementation of these covenants stops what we call partnership divorces which lead to severe emotional distress and significant financial loss. Members become accountable to each other through restrictive covenants which help maintain their focus on business objectives. Legal breaches are controlled through these restrictions which provide LLC members with legal protection to remove breaching members and start legal proceedings.
These provisions will only work if they receive proper drafting. The Texas court system reviews restrictive covenants intensely because they will not validate clauses which extend beyond reasonable boundaries. The enforcement of a non-compete agreement becomes impossible when it bars a member from working throughout the entire state for five years. The success of such language depends on exact wording when establishing removal for cause provisions. Your operating agreement needs to establish the definition of breaches along with the procedures for member removal and all available remedies that benefit the company. The established procedures protect both power abuse prevention and enable proper action against misbehaving members.
Beyond the Three Legs: Additional Considerations
The three-legged stool provides essential functions for LLC operating agreements yet several vital points need further consideration. The agreement needs to specify how profits and losses will be distributed among members. The business can distribute profits and losses according to member ownership percentages or it can use different distribution methods based on its operational structure.
All members need to understand the rules regarding their capital contributions including the amount they must contribute initially and the conditions for future contributions. Members need to understand their initial contribution requirements and any conditions that might trigger additional contributions. The agreement must establish a dispute resolution process through mediation or arbitration to avoid costly legal battles. The operating agreement needs to establish procedures for modifying its content including the voting requirements needed to accept changes. The dissolution provisions need to be included as a fundamental part because they explain the process of business closure along with asset distribution and liability management.
Why Customization Matters
A customized operating agreement acts as your essential protection against legal disputes and operational issues and misunderstandings between members. Standardized legal documents do not solve business-specific problems because they do not address the unique operational issues that your company faces. The cost of legal battles decreases while your rights and obligations become clear through a customized agreement which establishes a solid base for your LLC. An agreement tailored to your business needs ensures Texas law compliance which makes it court-enforceable and capable of adapting to your organization's distinctive operational structure and business targets.
The Johnsen Law Approach
At Johnsen Law we do not rely on downloaded generic forms. Our team dedicates time to know our clients' business needs alongside their objectives and business-related issues. Our process for drafting operating agreements follows the "three-legged stool" framework to create agreements that meet client needs with customized solutions. Our clients receive legal documents combined with strategic advice from our attorneys to build a successful future for their company through our detailed and hands-on approach.
Our team supports clients through the entire process of new LLC establishment or existing LLC reorganization while handling their legal and practical needs. Our approach ensures that every section of your agreement will help your business expand while maintaining stability through operation and control provisions and transfer restrictions and restrictive covenants.
Moving Forward
A well-constructed operating agreement functions like a three-legged stool which combines operation and control with transfer restrictions and restrictive covenants. Tailor your agreement to match your business requirements to safeguard all members. Collaborate with an attorney who specializes in business law to create an agreement that meets legal standards and holds up in court. A properly drafted operating agreement provides the most effective protection against expensive legal disputes and business partner separations. The Texas LLC foundations built by Johnsen Law create balanced and secure enterprises that are prepared for expansion.
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