Does your LLC Need an Operating Agreement?
The answer is most likely, “yes.” However, operating agreements are often overlooked, which can lead to some complications down the road for your LLC.
What is an Operating Agreement, and Why Does my LLC need one?
An operating agreement is essentially a legally binding document that lays out the members of the LLC’s rights and responsibilities. Some of these may include:
- Member hierarchy and structure
- Member elections/buy-out terms
- Capital contributions
- & more
Most states do not require an operating agreement, but it is highly recommended that your LLC takes the time to have a professional attorney draft one.
Key Considerations of Establishing an Operating Agreement for Your LLC
Clarifies Ownership and Management Structure
An operating agreement sets out the ownership structure of the LLC and outlines the percentage of ownership each membership holds, their rights, and the distribution of profits and losses. Each state has default rules in which the LLC is formed, and without an operating agreement those rules may not align with what your LLC needs and will be most successful with.
The operating agreement also clarifies the management structure of the LLC, stating whether it will be member-managed or manager-managed. This distinction is crucial as it determines who has decision-making authority and ensures all members are aware of their roles and responsibilities.
Protects Limited Liability Status
An LLC’s limited liability protection is one of its most significant advantages. However, this protection can be undermined if the LLC is not adequately structured or managed. By having an operating agreement in place, you demonstrate to the courts and other parties that your LLC is a separate legal entity. This separation is vital in maintaining the limited liability shield and preventing personal liability for the LLC’s debts and obligations.
An operating agreement functions similarly to that roommate agreement that you probably signed for your freshman dorm in college. Each person was responsible for payment, damages, roommate transfer or release, etc., and if there was a conflict, your RA was the mediator. An operating agreement functions in the same way in that an operating agreement sets the rules and procedures for the internal operations of the LLC. It provides for the exact roles of the members, their financial obligations, and how a member may enter or be removed from the LLC.
Importantly, an operating agreement outlines how disputes are to be resolved. Often, this includes mediation or arbitration, or other methods of conflict resolution. This saves time and money, allowing your LLC to continue running smoothly with little to no fallout.
Enhances Credibility and Attracts Investors
If you’re seeking external funding or looking to attract investors, having an operating agreement can greatly enhance your LLC’s credibility. Potential investors will appreciate the well-defined structure, clear terms, and risk mitigation measures that an operating agreement provides. It demonstrates that your business is well-organized and that you take its governance seriously, increasing the likelihood of securing funding or partnership opportunities.
Laws regarding LLCs and operating agreements may vary from state to state, so it’s crucial to consult with a legal professional familiar with your jurisdiction. Taking the time and effort to create an operating agreement tailored to your LLC’s specific needs will undoubtedly prove to be a valuable investment in the long run.