Updated: Aug 29, 2020
Operating agreements are one of the most important legal documents to understand when investing in any company or asset. Attorney John Shari will use his years of experience in corporate law to identify the key points investors should understand when reviewing or signing an operating agreement.
In addition to representing many clients in estate planning, for over sixteen years John M. Shari, Esq. has been employed by some of the most prestigious law firms on the East Coast, representing both Fortune 500 companies and private investors in commercial real estate and business transactions. Until recently, he managed a team as lead counsel of acquisitions for one of the largest U.S. telecommunications companies in the cellular sector. As Shareholder of his Firm, John’s goal is to help entrepreneurs achieve their dreams and estate clients to protect their family. His thoughtful and proactive approach ensures that the issues impacting their business or estate are addressed at the very beginning. In engaging John, you will find his belief in long term relationships reflected in the quality of his work and his timely response to your inquiries.
1:24 - Operating Agreements
8:45 - Thoughts on starting LLC
13:06 - LLC Purchasing property
14:16 - Contact
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Peoples Capital Group has been helping passive investors build wealth in NJ real estate for 10 years. Visit www.PeoplesCapitalGroup.com to find out if you qualify to start earning passive income and pay less taxes via investing in real estate. IRA's and 401K's are accepted.
Aaron Fragnito: All right, ladies and gentlemen. Welcome to the Passive Cash Flow Podcast. We have an amazing guest today. We have John Shari. Say hello, John. How are we doing today?
John Shari: How's everybody doing out there. Thanks for the introduction.
Aaron: [laughs] I think everyone's doing excellent. That would have been my assumption because it's a beautiful Friday. The sun is shining and the hurricane has come and gone. You know what? I think that this coronavirus, it's going to come and go as well. I got a good feeling. I think we're going to nip this thing in the bud pretty soon. What do you think?
John: I agree. Let's certainly hope so. Let's get this over with, get it behind us, and move on.
Aaron: Yes. I was driving around today. I saw more businesses opening up and I saw different things going on, so pretty interesting stuff going on. Anyway, John Shari, attorney here, talk a little bit about what you do and how you do it.
John: Sure. Well, I've been an attorney for over 16 years. I do, well, basically any sort of commercial transactions, commercial real estate. I represent a lot of investors and I represent a lot of lenders, just people generally doing business or selling their business and buying a business, and also some estate work. I have a mainly transactional focus practice. I believe one of the things you want to talk about today is operating agreements and LLCs.
Aaron: Oh yes, everyone's favorite topic.
John: Back to the world of LLC operating agreements.
Aaron: Oh yes, back to the real world. [laughs] LLC operating agreements are arguably the most important document we execute with our passive investors who are buying a piece of real estate. Here at Peoples Capital Group, as you know, as our attorney, permitting commercial transactions. We buy apartment buildings with passive investors and we give them equity in these buildings.
One way we protect our investors and work with our investors is through an operating agreement, which overviews their risks and rewards and the rules in the company here. As our attorney that helps us with those operating agreements, what are some of the most important things people should look for when they're reviewing an operating agreement?
John: Well, there's a lot of things actually. Before we even get into that, let's take a little step back and just talk very briefly about what actually is an LLC.
Aaron: Of course.
John: LLC is basically just a legal form of entity. You may have heard of C corporations, S corporations, limited partnerships, sole proprietorships. LLC is unique in the fact that they offer limited liability to the investor, which means that an investor, once you give money to the LLC, only that money is at risk. None of the investor's personal assets are at risk. There are some very, very rare exceptions to that. For the most part, that rule holds true. Any personal assets of an investor are protected. When you hear the word "limited liability," that's essentially what that means. There's some more benefits of the LLC. It's very, very flexible.
You can choose the tax status you want. We don't have to get into depth right now, but just know that's very, very flexible and it's especially good for investing in a real estate. To go back to your original question, what kind of things does an investor really want to see in the operating agreement? The operating agreement is essentially like the terms of how the partners and investors will not only operate the company but also how those investors treat each other and what they can and can't do. For an operating agreement, you want to make sure, obviously, that, first of all, you have an operating agreement with the investment in the LLC.
Aaron: Pretty important.
John: It's not required technically by law. I don't know if you know that, but it's always smart to certainly have one. The operating agreement will basically have the formation, what are the names of the registered agent, the person who receives any kind of mailings from the government or correspondents from the government? It will go through how the company itself operates, when expenses are paid, how compensation is paid.
It will go through things like when the LLC has their annual meeting. Does it have it in January? Does it have more meetings? Especially important for investors is voting rights. How are the voting rights structured? Most operating agreements-- and the smart way to structure it is to allow the managing member to do whatever they need to do during the ordinary course of business without requiring a vote of all members, but then only have a vote required of all members for certain specific events like adding a new member like selling the property or any big events.
You don't want to run a business where every single little purchase, every $5, $10 purchase, you actually have to go back to the investors and ask them if it can be done. You generally want to structure it so the people who are running the business can run the business effectively and efficiently, but the investors also have the power to approve the non-ordinary course events, the big events that happen.
That's always a very important thing for everybody to take a look at and what things are voted on and how and what requirement or level they're required to vote on. In other words, do you just need a simple majority? Do you need two-thirds majority? Do you need full unanimous vote on certain things? Those are certain important considerations to look at as an investor in any business or LLC in this case.
Aaron: Right. To go a step further, if the members don't have voting rights and you're putting together a pool of investors like we do and the members are passive investors, silent investors, non-voting members, then you have to file with the SEC most of the time, right? That falls into the security.
John: That's a little different. That's another conversation. Yes, that's a private placement agreement of, usually, a 506(b) or a 506(c) application to the SEC. Basically, just letting the government know of the offering because, technically, it is a security offering similar to GM would do if they were offering stock. You still have to follow certain guidelines as a sponsor. You always want to invest with sponsors or syndicators who understand that concept and who properly do things by the book.
It's certainly a good point for you to bring that up. To go into that any further is going to require an hour in it of itself discussing that. As an investor, just know that there are some security laws that have to be taken care of by the sponsor. Whenever you're talking to a sponsor and they understand that, you're obviously dealing with a more sophisticated sponsor.
Aaron: Absolutely. That's what we do whenever we're closing on a piece of real estate. Of course, we do file with the SEC because our investors are non-voting members. That's required to report that to the SEC. It's interesting in real estate at the different ways people could structure things and the different rules people have. That's incredible. I didn't know you could have an LLC without an operating agreement. Have you ever seen that before?
John: Yes. Usually, there's nothing, at least under New Jersey law, that requires an LLC to have an operating agreement. More often than not, people who are single-member LLCs will not have an operating agreement because they just don't really need too. It's just them. The only case for a single-member LLC would require an operating agreement is if they're going to get a loan from a bank or some kind of other private lender who would require to see proof of an operating agreement to make sure that they're the only person there and that there's no funky approvals required, that sort of thing. Generally speaking, if there's more than one member in an LLC, you need to have an operating agreement. It's just not required by law.
Aaron: Right, exactly. If someone doesn't have an operating agreement and they're looking to have you draft one, what would that cost if you say you had just a few members in an LLC, not very complicated, but a few partners buying a piece of real estate?
John: It depends. If it's just a simple fix-and-flip kind of thing, there's maybe two partners and they're both contributing services to the business, it's not very, very difficult. It maybe would be an hour, an hour or two at most of work for me to do. If you're getting into more sophisticated joint venture agreements for development of real estate, then that's a different story.
It depends on what the deal is, what they're developing. It depends on how many members there are and how sophisticated those members are. That would be on the opposite extreme as very, very complicated, but a simple syndication thing is not too difficult to do. Certainly, for a basic fix-and-flip or investment of real estate, it's really just a couple of hours of work.
Aaron: Now, it's a little bit of a different topic, but I talk to people all the time that are starting businesses. They say, "Oh, well, I'm going to start my LLC in Delaware because there's sales tax benefits there" or "I'm going to start my LLC in Nevada because it's hard to pierce the veil of an LLC." I've also been told by attorneys that it really doesn't matter. The state you're doing business in is the state that the laws apply to. You might as well just start the LLC in the state you're doing business in. What's your school of thought on that?
John: Well, it depends, unfortunately. If you are a startup company and you want to be the next Facebook and you're getting or intend to receive professional money from venture capitalists, then you have to be a Delaware entity. There's no way around it because that's who they're used to dealing with. Venture capitalists get their money from pension plans and other things that will generally can't invest in LLC. It has to be a C-corp and generally do not like investing in any other states besides either Delaware and occasionally California. In that sense, if you're starting that kind of business, you need to be a Delaware C-corp.
Aaron: Why is that though? Is that because Delaware-- What's the benefit there?
John: Well, the benefit there is that in Delaware, there is a very, very highly established court system to process business disputes and issues. Investors, at the very high level for those technology investors of venture capitalist, they are used to Delaware law. They understand Delaware law. They're just used to using that state and investing in companies that have been formed in that state. They have to be C-corps for that.
You can't really, generally, not do an LLC for that because, again, the venture capitalist get their money from the big pension funds, the institutional investors who are technically in many ways not allowed to invest in pass-through entities, which is an LLC. For that sort of work, you need to be Delaware. If you're starting a small business like you're going to start a restaurant, you're starting a consulting company of some kind, you're investing in real estate in New Jersey, then you want to just be a New Jersey LLC.
It keeps things as simple as possible. You don't really need to go the route of having to go to Delaware to form a company, have a registered agent in Delaware. Actually, if you're doing mainly of your business in New Jersey, what you then have to do is apply in New Jersey for foreign entity approval to operate in New Jersey. It's basically you're really putting a lot of time, money, and effort into going through Delaware to operate in New Jersey. In those cases with a smaller business, you want to be in the state where you're operating.
Aaron: Well, what about the $30,000 education package gurus that tell you you should start an LLC in Nevada because you can't pierce the corporate veil in Nevada?
John: Well, that's not 100% accurate about not piercing corporate veil in Nevada. The corporate veil, I'm sure, could be pierced in Nevada. It's just that Nevada has very, very high confidentiality rules. Without a court order, they will not disclose who the members of the LLC are. That's why Nevada's very good. Also, Nevada's very good because I don't believe they have any corporate taxation.
One plan for people-- and is, again, a little bit more complicated, but one plan for certain investment vehicles and businesses is to start a Nevada LLC, elect S-corp status, and then transfer all your assets, let's say, in New Jersey. Let's say you own a pizzeria. You transfer all your assets to a Nevada LLC in terms of ownership, and then you pay and lease that equipment back to your other business.
That way, you're basically reducing your income tax in New Jersey and feeding it to the Nevada LLC, which has no corporate tax, at least at the state level. You can do some funky stuff with different entities depending on what sort of goals you have. For real estate right now, it's very, very simple, thankfully. You just, for the most part, have to have a New Jersey LLC if you're investing in New Jersey property.
Aaron: That's what we do. All of our LLCs are New Jersey-based. We run our operations out of New Jersey. Now, what if you're buying a property in a different state? Let's say I live in New Jersey, but I want to buy a property in Vermont. My operations are going to be primarily out of New Jersey management-wise and things like that. However, I am hiring people in Vermont to clean the properties and maintain them and service providers and sub-contractors. What would you suggest there? Would I just start a New Jersey LLC or would I start a Vermont LLC?
John: If it's a one-off sort of deal, in other words, you're just doing a raise for that property and there's no parent company structure, then you could just do a Vermont LLC and do it that way. Once companies get bigger, they may often not structure it that way. They may structure it whatever state they're from, and then that state invests in separate subsidiary companies and each subsidiary company owns a piece of real estate. Under that case, it'd be a little different. For each one-off, if you're buying a property in Vermont, it might as well just be a Vermont LLC.
Aaron: Interesting. All right, great. Well, that's some good information, I really enjoy what we're talking about here. Now, how can people reach you? What are some services that you would provide to just any type of business owner or a real estate investor?
John: Well, you can reach me on my website, jmstransactions.com. I have all my contact information there and there's a lot of information about the business and what sort of businesses I can help. I've been in-house counsel for a lot of businesses, so I can help with ongoing operations. I do a lot of formation startups of businesses as well as sales of businesses, and as I'm sure you know, a lot of commercial real estate and the occasional estate plan as well for certain special clients.
Really, I run almost the full spectrum of transactional type of work. I'm very easy to talk to. I like talking about these sort of things. If anybody has any questions about anything, any of the viewers, your viewers, feel free to reach out to me. I'd be more than happy to talk about whatever situation or business situation you have that I can help you with. If it's something that I can't help you with, I'll be more than happy to point you in the direction of some good people who can help you.
Aaron: Yes. I can definitely vouch for that. John's been a great attorney for us. You know what I like about you, John? You provide great service, but you don't break the bank. That's really important when you're trying to run a business.
John: I'm trying to have long-term clients and repeat business and people I like working with, good people just like you guys. I like working with you. I want to work with you guys in the future.
Aaron: Absolutely. What's your website one more time?
John: Jmstransactions.com. If you just do a search for my name, John Shari, last name, S-H-A-R-I, it'll pop right up.
Aaron: Man, I've been calling you John Sherry for the longest time.
John: [laughs] I've heard that all my life, so I don't even pick up on it. Technically, it's pronounced Shari, but Sherry works as well.
Aaron: Sherry, Shari, okay. That's good.
John: I've heard it both ways my entire life. Like I said, I don't even pick up on it anymore.
Aaron: [laughs] I know a guy, his name is Ryan and you call him-- He wants Ry-ann. You call him Ryan, he gets upset.
Aaron: Very confusing. I don't know. Pick or choose or you get upset about it as well.
John: Exactly. You got to let certain things just wash over you and just move forward.
Aaron: Yes, absolutely. All right. We'll put your website in the show notes so people will reach out to you. This is great. I think it's been very informative. I know it's a bit of a dry topic, but it's a very important topic. I could see your passion for it, which is great. Even on this beautiful, sunny day, I enjoyed talking about LLC operating agreements. Imagine that.
John: [laughs] Yes. The magical world of LLC operating agreements.
Aaron: Hey, without them, where would we be, right? We need these things.
John: That's true. You need them.
Aaron: Oh, my gosh. Where would we be? Those slip and falls, ooh-wee. Thank goodness for the LLCs.
John: That's right.
Aaron: All right, my friend. Enjoy your day there and you have a good one.
John: You too, you too. Have a great weekend.
Aaron: Thank you.