Why Does My LLC Need an Operating Agreement?
- August 13, 2019 3:39 pm
The government requires a lot of paperwork when you form a business, so you might think you’re getting a freebie if your state doesn’t require you to make an operating agreement for your LLC. Well, the government doesn’t require you to wear a coat when hiking through northern Alaska, either. Not even mittens or long underwear. So believe us when we say that, legally required or not, you absolutely should have an operating agreement. In fact, it’s the most important document for your LLC.
What’s an operating agreement? In short, it sets the rules for how your LLC will be run. It answers essential questions such as: Who are the owners, and how much of the LLC does each own? Who manages the LLC? Who gets to vote on important decisions? How are profits divided? What do you do when an LLC member leaves? What happens when the LLC is dissolved?
A good operating agreement addresses these questions and many others. Here are some more reasons you need one:
The whole reason you wanted to have a limited liability company instead of a sole proprietorship was to protect your personal assets and keep them separate from the business’s. But without an operating agreement in place, sometimes the courts will treat your LLC like a sole proprietorship, which puts your personal savings in jeopardy. The formality of an operating agreement makes your LLC look legit to the courts.
A lot of people go into business with their friends or family, so they aren’t as guarded as they would be with other business partners. But if you want those friends and family to remain friends and family, you should put things in black and white. Who is expected to do what? Who’s in charge of what? Who votes on who’s in charge of what? How are profits divided? What if one of the LLC decides to sell his portion of the LLC to that guy with the unibrow who used to bully you in junior high?
Spelling issues like this out at the beginning spares you from a lot of “but I thought” and “but you said” and “what I meant was…”
One perk of having an LLC instead of a corporation is the flexibility it gives you. With an operating agreement, you can use that flexibility to decide how you want profit and ownership structured. Say one partner puts in only 10% of the initial investment and the other puts in 90%. Maybe the majority owner is willing to take only 50% of the LLC profits in exchange for having a greater say in management or having to do less work in the daily operation of the company. You can set it up how you want it to be in your operating agreement.
Without an operating agreement, you will, by default, be subject to whatever your state’s rules for LLCs are. And, though these rules vary from state to state, there’s a good chance you won’t be 100% happy with your state’s. If you put up 80% of the capital for your hair styling LLC and Barb and Alice only put in 10% each and refused to work Sundays (even though you know they’re not really going to church), you’ll be displeased when you have to dissolve the LLC and the state says you must split the assets evenly with them.
Even if your state doesn’t need to see your operating agreement, others likely will. Most banks want to see your LLC’s operating agreement before they’ll let you open a business bank account. Potential investors or partners will want to see it. Financial and legal professionals may want to see the agreement when rendering any advice or assistance. And, if you’re buying real estate for your LLC, you can expect the title company to want to read your operating agreement, too.
“It’s just me in this LLC! Why do I need an agreement with myself?” you might say. Well, this isn’t an agreement with yourself, like a diet or New Year’s resolution or vow to never attempt to make fish tacos again. This is a document that says you’re a real business, even if that business consists solely of yourself. As we said, having the document helps establish to the courts that your business is a separate entity from you.
Also consider that an operating agreement is something that you might want to show to potential investors and business partners. It puts a plan in place for succession if you die or become incapacitated. But creating an operating agreement also helps you to really focus and think about your plan for the company and how you’ll deal with various scenarios if they arise. It gets you in the mindset to run a business.
The flexibility of an LLC gives you a lot of choices, and choices are daunting. With so many potential elements to include in an operating agreement, you want more than a business formation company that will just insert your name in a template and charge you $100. ZenBusiness specializes in tailoring our services to you and your business, and one of those services is helping you create the right operating agreement for your LLC in your state. Get your operating agreement in one of our plans today.
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