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Importance of an LLC Operating Agreement

An operating agreement is a key document used by LLCs to outlines the business' financial and functional decisions including rules, regulations and provisions. The purpose of the document is to govern the internal operations of the business in a way that suits the specific needs of the business owners. Once the document is signed by the members of the limited liability company, it acts as an official contract binding them to its terms.

A standard operating agreement will cover several key items, including:

  • The guidelines for the management of the LLC

  • How profits and losses are shared

  • Ownership and classes of interests

  • Fiduciary duties of members

  • Transfer of interests

  • Withdrawal of a member and dissolution of the business

  • Method of dispute resolution

What your operating agreement will have will depend largely on the type of business, the members of the LLC and your specific circumstances.

The Operating Agreement Describes the Organization

As noted above, an operating agreement describes the operations of the LLC - listing the formation of the business and the procedures followed in the business. The agreement also clarifies how LLC funds are contributed and distributed to the owner. This discussion is helpful to the owner and a good way to ensure that appropriate records are being kept of proceedings.

Separating the Business from the Owner

Having an operating agreement and keeping records of operations helps establish the separateness of the business from the owner for liability and tax purposes. If you don't have an operating agreement, you will find it more difficult to show that your business is separate from you. This is crucial, particularly in protecting the "corporate veil" of liability protection. Without the operating agreement, your LLC can closely resemble a sole proprietorship or partnership, increasing the chance that your "corporate veil" will fail and open you up to personal liability.

Clarifying Business Succession

An operating agreement also clarifies what happens if the owner dies or is unable to run the business. Effectively, the operating agreement creates a succession plan. Your operating agreement should include a clause stipulating who will manage the LLC if you are unable to do so. Without this specific provision, it may be difficult for your family to continue the business or dispose of it without a lengthy legal battle. This section of the operating agreement is particular important if you want to pass the business on to a family member. It is highly advisable to consider this aspect of your operating agreement in tandem with your estate plan to ensure that the business passes smoothly.

Avoiding State LLC Default Rules

If an LLC has no operating agreement, it is subject to the "default rules" of the state in which the LLC is organized. These "default rules" are set out by the state. Letting the state tell you how to dispose of your business assets is not what you want for your LLC. There is an extremely high chance that the default rules of your state will not dispose of your business in the manner you would want.

Get Help from An Attorney

Your attorney can make sure all the relevant clauses are included, and he or she can tailor the document to the requirements of your state. It is highly advisable to have an attorney work with you to ensure your operating agreement is perfectly tailored to your business needs and wants. Working with an attorney, such as Elizabeth Mitchell, esq. of The Rose Law Firm, who specializes in business and estate planning can help ensure that your succession plan and estate plan work in tandem to make the transition as seamless as possible.

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