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If you’ve decided to organize your business as an LLC and you’ve filed the necessary paperwork with your state, you may be wondering if you need to draft an operating agreement for your new business. The short answer is: yes. You need an operating agreement.
While it’s true that many states do not legally require LLCs to have operating agreements, it’s unwise to run an LLC without one, even if you’re the sole owner of your company.
Reasons Why You Need an Operating Agreement
Creating and following an operating agreement will help to protect your limited liability status, prevent management and financial misunderstandings, and make sure your business is governed by your own rules, not default rules created by your state. Let’s explore these reasons a little more fully.
#1. To Protect Your Limited Liability Status
The main reason to create an operating agreement for your LLC is to help ensure that courts will respect your limited personal liability. This is especially important for a single-owner LLC, because without the formality of the operating agreement, the LLC will look a lot like a sole proprietorship. Having an operating agreement lends credibility to your LLC’s separate existence.
#2. Defining Management and Financial Structure
If there is more than one owner in your LLC, you need to lay out each co-owner’s rights and responsibilities in the operating agreement. This includes decision-making protocols and how profits will be shared. The operating agreement should also address the procedures that will be followed if an owner decides to leave the LLC. Additionally, without an operating agreement, you and your co-owners will be ill-equipped to handle any misunderstandings over finances and management.
#3. Overriding State Default Rules
In each state, there are laws that set out the basic operating rules for the LLCs within that state, some of which would govern your LLC unless it was stated otherwise in your operating agreement. These are commonly referred to as “default rules.”
For example, unless it’s otherwise-stated in the operating agreement, many states require that all the members of an LLC divide up the profits equally, regardless of how much each member has invested in the business. If you have invested more into the business than one of your co-owners, you probably do not want to divide up the profits equally, which is why you should have an operating agreement in which you spell out how you and the other co-owners will split profits and losses.
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