Business

Who Needs an Operating Agreement?

June 24, 2021

If your business is a Limited Liability Company (LLC), an Operating Agreement is not always legally required, but practically speaking, it is an essential document for multimember LLCs.

  • Operating Agreements lay the right foundation at the outset for the LLC.
  • Without an Operating Agreement, state laws govern the LLC, as a default.
  • Even single-member LLCs might need an Operating Agreement.
  • A well-written Operating Agreement can help to avoid future disputes among the members of the LLC.

What is an Operating Agreement?

Operating Agreements govern the rights and obligations of the members of an LLC. At a minimum, the Operating Agreement should indicate how profits will be allocated, when capital can be injected, the criteria for borrowing on behalf of the company, and how disputes will be resolved. The agreement is basically an internal rulebook.

Benefits of an Operating Agreement

An LLC with multiple members benefits from an Operating Agreement because it clearly states all of the members’ expectations and obligations. Simply put, it makes sure everyone is on the same page and records critical decisions regarding how the LLC should be run. In addition, an Operating Agreement makes the decisions enforceable. If one of the members goes against a rule specified in the Operating Agreement, the other members are able to impose penalties and can bring legal action against the offending member.

Does every LLC need to have an Operating Agreement?

Operating Agreements are not legally required in most U.S. states for single member LLCs. Nevertheless, as a practical matter, you will want an Operating Agreement.

Businesses without Operating Agreements are governed by whatever laws apply in the state where they were formed as a default mechanism. This means that members would have to rely on state law to give them the ability to impose a penalty or bring legal action against an offending member. Most states’ LLC statutes do not cover all of the day-to-day operational issues that can arise. This makes disputes between members difficult to resolve because it often leaves members with no recourse other than dissolution. To ensure that important agreements between members are enforceable, it really is in the members’ best interest to have an Operating Agreement so that they have reliable enforcement mechanisms.

For LLCs with only one proprietor / owner, there may still be a practical necessity for an Operating Agreement. Many banks and vendors will want to see an Operating Agreement before extending credit to an LLC.

Why do I need a lawyer?

Anyone who needs an Operating Agreement is likely to use their favorite search engine to learn about them. If you are one of these people, you will find many websites offering Operating Agreement templates and forms free of charge. However, it is dangerous to use these forms for your Operating Agreement.

They are typically not nearly detailed enough, which can render them effectively useless. Furthermore, merely downloading and using Operating Agreement templates from the internet deprives you of an attorney’s advice and experience in this critical process of starting your business. An attorney can help you to foresee and avoid situations which could deadlock the LLC. A form downloaded from the internet cannot.

Unless you are willing to do background research to make sure that the template includes all of the needed language and information, you will not know if your Operating Agreement includes everything you want, such as safeguards against diluting members’ interest, or if the language is even enforceable. At that point, you are essentially doing a lawyer’s job without the training needed to do it well.

Further, templates are only useful if your business fits the cookie-cutter. If you want specific agreements to be enforced, an online template cannot write that for you. It may not even tell you that you have the option to include clauses not held in the template. A lawyer, on the other hand, can draft language that is specific and enforceable, and will personalize the agreement to your unique circumstances and specific business needs.

Conclusion

Every LLC should have an Operating Agreement, and not just any Operating Agreement. To save yourself from potential problems in the future, the agreement should be reviewed by an attorney prior to signing.