1.) No matter how well you and your spouse get along, it’s a good idea to create an operating agreement upon forming an LLC for your farm business. The operating agreement outlines how the LLC is to operate. This is important because operating in accordance with an operating agreement proves that you both are earning the LLC’s liability protection. Plus, if you don’t have an agreement, state law will fill in the blanks as necessary. The default provisions provided by state law may not be suitable for your farm operation. The operating agreement gives you and your spouse the opportunity to write your own rules. Moreover, it allows you to set more favorable ground rules in your relations with third parties. The operating agreement may not seem to matter much for a couple that has a close working relationship. They could agree on each of the issues addressed here in a casual conversation and that may be good enough. However, if it’s not written down in an operating agreement, it won’t govern anyone else who was not a part of that conversation. For example, let’s say a creditor comes after one of the spouses and takes control of their LLC interest. The creditor must follow the operating agreement, which could say that such a creditor would have no voting rights. This Brief Operating Agreement for Happy Couple Farm, LLC includes the foundational provisions that are particularly important for a married couple LLC. It presumes that the couple’s communication and working relationship are relatively good. This Brief Operating Agreement assumes that if the couple divorces, marital or family law may dictate the division of assets to a certain extent, aside from what an operating agreement might require. So the provisions are not as elaborate as some operating agreements. If you think that you will eventually take on new business partners outside your family, you may want to take a look at Farm Commons’ Extensive Operating Agreement for Sun Sisters Farm, LLC. This operating agreement is for a Wisconsin business. If you use it as a starting point, be sure to make necessary changes to reflect your state.

2.) “Members” means the same thing as “owners.” Because LLC law uses members, we do too.

3.) Married couples that live in specific states may choose to form their LLC with one member–the married couple as a single unit. This option is available to couples in states that adopt “community property” systems. The nature of community property is way beyond our scope here! To summarize, some married couples may want to form a single member LLC for tax reasons. Married couples in community property states should talk with their accountant or tax preparer about their options. If you were to form a single-member LLC as a married couple, you should still consider creating an operating
agreement. As explained above, the operating agreement helps address matters with third parties and also provides the procedure for shutting down the business. Note that in our story, Jackie and Pat have decided to form a multi-member LLC even though they live in a community property state. Again, check with your attorney to find out what’s best for you.

4.) This section creates the official link between the state-filed articles of organization and this operating agreement. It’s not necessary, just recommended.

5.) These aren’t the only terms and conditions for running the LLC. In running everyday matters, owners set all sorts of rules or policies for how to conduct business or make decisions. The operating agreement is the place for baseline foundational rules, such as who owns the business, how members make decisions, how disputes are resolved and how to get out of the business. Day-to-day operational matters are generally not included in an operating agreement.

6.) This section is not legally necessary. It’s an opportunity for owners to incorporate the business purpose into the legal structure of the farm. The purpose can be binding in that an action taken by a member in opposition to the business purpose could be invalid. But, the phrase “… and to conduct any other lawful business” takes any teeth out of the purpose. Many farmers like incorporating a purpose into the operating agreement because it feels good to remind owners why they farm in the first place.

7.) This provision basically allows you to bring on new members if both you and your spouse agree. However, one exception applies here. Section 5.2 provides that one spouse can transfer some or all of his or her interest to a child or grandchild without the consent of the other. This simplifies matters in times of death of one spouse or, potentially, divorce. Basically, each spouse can determine how to divvy up his or her interest in the company to the children or grandchildren. This is just one way of doing it. You could require unanimous consent for all transfers.

8.) “Capital Contributions” are the assets each member contributes to the LLC. Assets contributed can be cash, equipment, services and other things of value. (Note that we strongly urge you to see an attorney or accountant before you contribute services because there are tax implications). The section on Capital Contributions is important for several reasons. First, although an LLC provides protection for personal assets, assets contributed to the LLC are no longer personal. In effect, members are liable for the LLC’s debts to the extent that each has contributed to the LLC. That’s why it’s important to get the exact contribution in writing now and into the future. In addition, an LLC needs to be adequately capitalized to be legally legitimate. How much capital do you need? Common sense suggests that you need enough to pay bills as they come due. If you can do that with cash flow from revenue, you may not need much capital.

Of note, we need to make a distinction between a capital contribution and a loan, lease or sale. You can loan your LLC cash, or sell or lease your LLC land or equipment. None of these situations is considered a capital contribution. For example, a member could loan the LLC a total of $1,000 for the opening bank account balance. This could cover the business until cash flow is sufficient to pay the member back. Unlike a capital contribution, the member has a right to be paid back for the loan. Of course, if the business folds, the business may need to pay off other creditors first and the member could end up losing that money in the end. Also, a member can sell or lease the LLC physical assets such as land or equipment rather than give the physical assets as a capital contribution. Loans, sales and leases should all be separately documented.

So now you must ask yourself: Exactly what capitalization and contribution arrangement is best for your farm operation? It will depend on several factors: costs of starting up the farm, expected cash flow, expected expenses, expected revenue and more. Contributions, expenses and revenue all determine income at the end of the year, which determines the members’ tax obligations. This subject can be quite detailed. Bringing the farm business plan to an accountant is the quickest way to get answers to these questions. Also, bear in mind that farmers can make additional capital contributions, which may change the percentage interest breakdown, so the initial decision isn’t necessarily set in stone.

9.) Each member must officially transfer whatever capital contribution they have promised. If they agree to contribute cash, they will need to deposit the cash in the LLC’s bank account. If they agree to contribute land, they will need to transfer the title of the land to the LLC.

10.) The “Percentage Interest” is the LLC way of saying “percentage of ownership.” Basically this section boils down to if you contribute half the capital to the entity, you get half ownership. The percentage interest of all the members together will always equal 100 percent. It is possible for LLC members to allocate ownership in percentages that are not equal to capital contributions, but that subjects everyone to more complicated tax rules. Don’t do that without consulting an attorney and accountant. As this agreement is written, the percentage interest breakdown in the company determines the weight of each member’s vote. If one member has 60 percent percentage interest, then his or her vote will count 60 percent, or an automatic majority. Another option would be to make it one person, one vote so that each member’s vote carries the same weight despite the percentage interest breakdown. Yet another option would be to tier the membership interests, which could include voting members and non-voting members. Incidentally, this agreement usually requires unanimous consent, so it wouldn’t really matter.

11.) Because a capital contribution is the member’s exposure to liability, as explained in footnote 8, this section specifically states that members are not required to contribute additional resources. Generally, a member wants to limit the total contributions to the LLC. As long as the LLC has positive cash flow and can reasonably be expected to pay all of its bills, members might consider making loans to the LLC for ongoing needs. This is illustrated in our example above with the $1,000 cash loan to the LLC from
Jackie and Pat. However, some LLCs may want to require future or ongoing capital contributions. This could happen if the members expect that the farm operation will undergo a significant expansion and bank loans would not be an option or desired. If members require ongoing or future capital contributions, the members should have more complex rules including penalties or policies for default if a member fails to make the required contribution.

12.) Exhibit B needs to be actively maintained if you add any more capital in the future. This is because Section 3.1 states that profits and losses are distributed according to Exhibit B. The modification of Exhibit B is an amendment to the operating agreement, so the approval of all members and recording of the change are required. You should update Exhibit B as soon as you give the business money. However, it can also be done at tax time, when you have the whole picture at hand. Either way, it’s a good idea to have your accountant or tax attorney review any changes you make and go over any
tax implications. Again, as mentioned in the footnotes above and illustrated in the example, a person can loan personal money to an LLC. However, loans do not go on Exhibit B, because they are not a capital contribution.

13.) If new members are added, they may be required to invest or make a capital contribution to entitle them to a percentage interest or ownership share in the company. Another option for adding new members would be to transfer interests from existing members. This is addressed in Section 5. Either way, the percentage interest will always equal 100 percent and must always be recorded on Exhibit B.

14.) The capital account is a line item account. It exists on a spreadsheet or in a QuickBooks file, for example. It’s not a bank account. The capital account is maintained for tax purposes. This section outlines the basic procedures, which are also outlined in federal tax law. Very detailed capital account regulations are at Treasury Regulations 1.704-1(b)(2)(ii)(b)(1), (b)(2)(iv). If you file your own taxes, you will need to know these basics. If you work with an accountant or tax preparer, they should know these procedures.

15.) To summarize, a member’s “stake” in the LLC is the total of what the person puts in, the member’s share of the profits and the value of any debt the member personally takes over from the LLC. A member’s stake is reduced by any property the LLC gives to the member personally, the losses it gives the member and any debt the LLC takes over for the member. Here, Jackie and Pat’s stake in the company is the farm property. If the business goes south, they could lose the farm property. However, so long as they keep their personal affairs separate from their business affairs and do their best to reasonably capitalize the company, they will not be at risk of losing their personal assets.

16.) Overall, this provision states that members are not entitled to simply ask for their investment in the company to be returned. Without a provision like this, state laws might allow a member to withdraw from the LLC upon giving notice to the members. The problem is that a withdrawing member gets the return of their contribution to the LLC. The farm may not have the cash to pay back the capital contributed. So, this section states that a member doesn’t have a guaranteed right to withdraw. Instead, the LLC can allow a member to withdraw only if the parties unanimously agree. Here, the members have to agree on the terms of the withdrawal, including when and how a withdrawing person is to be paid out for their percentage interest.

17.) A capital contribution is not a loan. The members are not entitled to any interest on
the amount they contribute.

18.) Allocating profits and losses is done to calculate taxes—it doesn’t necessarily mean you hand out money. Members may not actually see any cash from the profit because the business is probably putting profit back into the business—not paying it out. That doesn’t matter to the IRS, however. This is because an LLC does not pay taxes on its profit. Instead, the individual members report the LLC’s profits and losses on their individual tax returns. The members will each pay income tax on their share of the profits whether or not they actually receive the money. If members get cash or property from the LLC, then the LLC is making a distribution. That’s addressed in the next section.

19.) Oftentimes, married couples contribute marital property that they own in equal halves, so all profits and losses are allocated equally. This is the case in our example, where Jackie and Pat own the farm property, tools and equipment equally. However, if one member makes additional contributions and the percentage changes, the profit and loss allocation changes as well.

19.) (cont.) Profits and losses can be allocated in a way that is separate from percentage interests. LLCs are popular because of this flexibility that is not permitted in a corporation. However, there are detailed tax regulations as to how losses can be assigned. By assigning profits and losses according to your percentage interest, you can be comfortable that you are complying with those regulations. If a member wants to make changes to loss allocations (which may be desirable if one member has a unique tax situation such as an inheritance or large salary), check with an accountant or attorney before taking action.

20.) A distribution is where the LLC actually gives members money or property, above and beyond any salary or wage members already receive for their duties. Distributions are essentially shares of the total profit, above and beyond expenses (including salary) of the business. Again, this is different than allocating profits and losses for the purposes of paying taxes on that amount. This provision requires unanimous consent before profits in the company are distributed to the members. It’s good to state specifically that a member cannot demand that they receive the business’s profit in cash. The company
might wish to always put profit back into the business rather than pay it out. However, you are free to make distributions as you wish. You could, for example, only require majority consent. Or you could provide that any profit above a certain threshold at the end of your year must be distributed to the members.

21.) State LLC statutes usually prohibit distributions under certain circumstances, so this provision basically reinforces the law. For example, members can’t give themselves the business’s assets if doing so would jeopardize its ability to pay the bills. This would subvert the liability protection offered by an LLC.

22.) This provision establishes the LLC as a “member-managed LLC.” Basically, the day-today affairs are managed by the members themselves. Some LLCs choose to be managed by an appointed manager. This is called a “manager-managed LLC.” For an example of this structure, see the Extensive Operating Agreement for Sun Sisters Farm, LLC.

23.) This is a somewhat confusing phrase. Basically, this section defines how the entity itself makes decisions. This should not be confused with how the members conduct the farm’s day-to-day business affairs. Section 4.1 explains that the members each have the authority to perform the usual tasks required to run the farm, and no vote is needed. Under some circumstances the members might need to make “big” decisions together, and they do so by following this process. The default threshold for such big decisions in this agreement is majority consent. Incidentally, many of the provisions in this agreement specifically require unanimous consent. Any provision that requires unanimous consent will overrule the default of majority consent.

24.) This seems a bit silly with only two members. If each member has half the ownership, both members must attend to have a quorum and you both need to agree in order to get majority consent. This section is really only useful if another member is added. (In that case, you may want a more thorough operating agreement.)

25.) For a farm that has only two spouse members and each has 50 percent interest, if they have majority consent they also have unanimous consent. So, it could be silly to also list out things that require unanimous consent. But, if one person contributes additional capital, that person has more than 50 percent ownership and then holds majority consent. In that case, only these items that specifically require unanimous approval would need the consent of the minority member. By including these details, this operating agreement may be useful if an additional member, such as a child, is added in the future. If a member does something like sell the LLC without consent, that action is invalid and the member who didn’t participate in the decision may have some recourse.

26.) Members generally want to unanimously approve any additional members or capital contributions because they can change the percentage interest breakdown. However, here, Section 5.2 allows each spouse to transfer his or her interest in the LLC to their children, to each other, or to a trust without the consent of the other.

27.) Here’s a plain-language summary of Article 5: A member can’t sell or give away his or her interest in the LLC to anyone other than their children without approval of the other member. If the person does, the transfer is invalid. If someone takes over a member’s interest in LLC (the most likely scenario being a creditor seizes it) then the new member receives distributions only—not voting rights. It is necessary that the more exacting, technical language of the section be accurate.

28.) This means members can transfer interests to each other, to children and to any trust members might create to manage property or assets, without first getting unanimous consent. This is most useful regarding wills: If members leave their interest to each other, their children or a trust, it may be easier to execute with this provision. Check with an attorney for more information on planning the estate.

29.) A void transfer means it’s as if it never happened. That means that even if Sonja sold her share of the company for cash to her best friend Erika without consent, the transfer is void. Sonja would still be a member and could still conduct business on behalf of the LLC. If Erika, not knowing that the transfer is void, votes or takes action on the LLC, those actions are void.

30.) The first part of this section makes it difficult to transfer membership—all members need to approve it. But, the second part adds an exception. Transfer is permissible without unanimous consent to certain people such as children, other members, the Company and other entities such as a trust.

31.) This means that if one member never receives notice that a creditor has seized a member’s interest (in subsection c) as required, then the member isn’t responsible to find out themselves.

32.) Members can always admit an Involuntary Transferee as a member (i.e., give them voting rights, etc.), if wanted.

33.) Assignment is different than transfer of an interest. Assignment means that the person gets the profits/losses/distributions but cannot vote. Transfer means that the person gets profits/losses/distributions plus voting rights. Some state LLC statutes allow a member to assign his or her interest at any time, in whole or in part. This provision, instead, prohibits assignment. Many LLCs prohibit assignment because they don’t want a member voting on LLC matters if the member does not have a financial interest in profits and distributions.

34.) This section is basically restating Section 2.4: Members cannot withdraw and demand return of their capital contributions or capital account. It can be useful to repeat just to be sure it’s clear.

35.) Although no single member can withdraw without consent of the other members, both can vote to dissolve the entire company.

36.) This means that if an LLC is dissolved, members won’t ignore the dissolution by carrying on business as usual.

37.) This means that if members make an honest mistake or do something innocently dumb and cause the Company harm, the Company or a third party can’t sue the member for it.

38.) An indemnification provision is simply a promise by another party to cover your losses if he or she does something that causes you harm or causes a third party to sue you. Indemnification provisions can vary quite a bit. Here, this indemnification provision means that if someone sues members for something they did on behalf of the LLC, the LLC has to pay to defend that lawsuit. An LLC should consider carrying insurance for this—without insurance, the business probably can’t afford to follow through on this provision. Farm liability insurance may or may not provide this coverage. A commercial policy might be necessary.

39.) It is highly recommended that you include a dispute resolution clause. Keep in mind that a dispute may come into play with third parties, such as creditors. Here, mediation is preferred as it is generally the least expensive and most efficient way for resolving disputes. While many consider them effective for achieving just outcomes, both litigation and arbitration can be timely and expensive regardless of a “winning” outcome, the former more so than the latter. So as a safeguard, consider the worst-case scenario, a super-messy dispute involving facts and he said, she said opinions, and then determine how you’d want the dispute to be resolved so that you can get on with your farming operations.