5 Reasons Your LLC Needs an Operating Agreement
It’s an amazing feeling establishing your own Limited Liability Company (LLC). You’ve put in the time to fully plan out your business idea. If you’re like me, you probably spent hours debating on names, only to find that many are already taken. Your $99 filing fee has been paid and you finally get that email from the Secretary of State.
Approved!
Congratulations! You now have your Articles of Organization. Your business is now registered with the state. So, now all you need is your EIN and bank account, right?
Wrong.
Your LLC needs a governing legal document much like a corporation does. You need what we call an Operating Agreement.
What is an Operating Agreement?
Your Operating Agreement is the legal document that establishes in writing, how your LLC will be run. This agreement allows you to outline the ownership of the company, roles and responsibilities, how profits (or losses) are shared, and membership changes.
It’s also standard for owners (members) to establish how they would wind up business affairs if the company were to dissolve. These are all major rules and structures for the LLC and can help address issues as the eventually arise. Having an Operating Agreement drafted is the best way to build a structure that works best for all members.
For your personal protection and the best interest of your business, we highly recommend that all LLCs have an Operating Agreement. Although most states (including Ohio) have default provisions in place for LLCs, there are very powerful benefits to having your own provisions customized to your company needs. Below, we’ll give you 5 reasons your LLC needs an Operating Agreement.
1. Protect Your Limited Liability
There’s an uncomfortably high likelihood that your business will be sued at some point. This is especially true as you start to generate success. It would be quite risky to go into court without an Operating Agreement in place, particularly if the LLC is owned by a single member. Not doing so could jeopardize your personal liability protection, as you could be viewed by the court as a sole proprietor.
If the court sees that you have formalized the company by governing it with an Operating Agreement, your liability protection will be viewed favorably. The safe bet is to get with a business lawyer and have your agreement drafted. Skipping this step could be very costly down the road.
2. Tailor Your Business Structure
One of the great benefits of an LLC is the flexibility in how a company designs its structure. Members are able to determine how to split profits, how to distribute membership interest, and establish responsibilities. This means that profits and losses aren’t determined based solely on capital contributions.
Members can decide to split profits differently. A member can make a 30% capital contribution while their partner makes a 70% capital contribution, and still set up a 50/50 split in profits and losses based on other contributions. This flexibility doesn’t exist with all business structures and the state won’t set it up for you. You’ll need an Operating Agreement in order to take advantage of this flexibility.
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3. Your Operating Agreement Overrides the State Default LLC Rules
We constantly hear “I don’t need an Operating Agreement; my state has LLC laws.” Well, sure, but how does that align with your business interests?
Without an Operating Agreement, your state’s LLC provisions will govern your LLC. Not all the state provisions will fit the needs and goals of your company. Most business owners find it better to hire an attorney to draft an Operating Agreement complete with guidelines customized to how you want your company to operate.
It’s important to understand that there are certain state LLC rules that your Operating Agreement cannot override. Be sure to consult with your attorney to learn more about which provisions cannot be avoided.
4. An Operating Agreement is Required by Many Banks and Investors
It’s not uncommon for your bank to require an Operating Agreement. Many banks won’t let you open a business account without having this legal document. If your LLC wants to take out a loan, your lender might want to see your governing document. Moving forward without an Operating Agreement can severely limit your access to capital and business transactions.
Investors often require your company have an LLC Operating Agreement as well. Investors and lenders generally have a vested interest in confirming the legitimacy of your business before lending or investing. Don’t limit yourself. Businesses need access to capital. The trustworthiness and competence built into an Operating Agreement will allow your LLC to sit at certain table.
5. Succession Planning in Your Operating Agreement
LLCs with more than one member (multimember LLCs) should be sure to have an Operating Agreement in place. This is important not only because it establishes a contract between the members, but the agreement also answers the following business succession questions:
· What happens to your company when one of the members becomes disabled, passes away, divorces, retires or seeks to sell his or her interest in the business?
· What happens to your interest in the business if you die or become disabled?
The Operating Agreement controls what happens in the above scenarios. You don’t want to be forced into business with your partner’s widow or ex-spouse. That’s not what you signed up for. Be sure that your attorney spells out the next steps to fit your needs. Plan for these situations in your Operating Agreement by including Buy-sell Provisions.
Nalls Davis has handled many disputes amongst members of LLCs largely because they simply don’t have an Operating Agreement in place. We often see infighting within the LLC, it doesn’t matter if your business is a new startup, or a seasoned business; if you don’t have an Operating Agreement or used a DIY template, we urge you to schedule a FREE consultation to ensure full protection of the law.
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