An operating agreement is a contract between members of a limited liability company, or LLC, that governs the operation of the business and solidifies some of its basic functions. For example, an operating agreement will outline the management structure, the ownership interests of each of its members, distribution of profits and losses, operating procedures, and proactively address unplanned events in the future. An operating agreement is an important step in placing your business on strong legal footing.
Why is it Important to have an Operating Agreement?
It is important for any LLC to have an operating agreement to solidify core business decisions and plan for the business’ future. Operating agreements provide four main benefits:
- Strengthen Liability Protection: An operating agreement can help strengthen the liability protection provided by LLCs. One of the primary purposes of creating an LLC is to limit one’s liability in the event the business becomes liable to a third-party. Though an LLC does shield its owners from personal liability, this shield may be pierced if your LLC is treated as an extension of its members rather than as a separate legal entity. Commingling business and personal affairs may subject an LLC’s members to personal liability (called “piercing the corporate veil”) in the event your LLC is liable for any debts or damages to a third-party. An operating agreement can avoid this by setting forth business formalities that show you are treating the LLC as a business separate from its members.
- Define Ownership Interests and Management Structure: An operating agreement will outline the ownership interests of each member and key management structures of the business. A good operating agreement will clearly define whether the LLC is member-managed or manager-managed, specify how profits and responsibilities are to be distributed among members, and state how ownership interests may be transferred. Without an operating agreement, common law and statutory “default rules” (which apply absent an agreement to the contrary) will apply. An operating agreement can define how, to whom, and under what circumstances the members’ ownership interests may be transferred in the event one or more members leave the business.
- Avoid or Resolve Disagreements: An operating agreement provides business owners with an opportunity to ensure any agreement between members is in writing. Oral agreements can lead to misunderstandings which may drastically impact business decisions. With an operating agreement in place, core decisions about the business are reduced to writing and agreed to by all LLC members. If there is a conflict about an agreement previously made, the members can look back at a written agreement rather than having to rely on their memory and understanding of any oral agreement. Operating agreements can also contain provisions for resolving disputes between members should any arise in the future.
- Plan Ahead: An operating agreement can help a business plan ahead for changes in the business and manage its growth. An operating agreement allows members of the LLC to agree in advance on how new investors may be brought into the business. The operating agreement can also clarify what happens upon the sale, expansion, or dissolution of the business.
Does a Single-Member LLC need an Operating Agreement?
Although crucial for multi-member LLCs, an operating agreement is recommended even for single-member LLCs in order to clearly establish the LLC as a separate legal entity and provide clear procedures for the business as it grows over time.
Contact us
An operating agreement should be tailored to fit the specific needs of each individual business and is not a one-size-fits-all document. It is important to consult a business attorney to create terms that will work best for your company. Contact Forrest McPadden at (860) 757-3828 or fill out the contact form below to work with experienced attorneys to create a customized operating agreement that aligns with your business goals and ensures your business’s long-term success.