An operating agreement is a contract that controls your LLC’s operations as well as member interaction with each other and with the LLC. You may think that an operating agreement is not necessary for your single-member LLC—after all—why make an agreement with yourself?
A Written LLC Operating Agreement Helps Limit Liability
No state requires an LLC to file an operating agreement with the Secretary of State. Instead, the operating agreement is kept with other business records. Most states don’t even require an LLC to have a written operating agreement. In California, an LLC Operating Agreement may be in writing or oral.
However, the better practice is to have a written agreement.
REASON 1–Keep Business and Personal Identities Separate
A written LLC operating agreement is evidence of a formal structure to the LLC. It helps distinguish the business from the owner for liability purposes. You likely formed your LLC for liability protection: the LLC protects a member from business liabilities and the business assets from a member’s personal liabilities. A written LLC operating agreement demonstrates that the entity is separate and apart from the member/owner. Without a written LLC operating agreement in place, the business looks like a sole proprietorship, with no liability protection. If a court doesn’t see your LLC as an entity separate from you, you could lose the liability protection that an LLC offers.
REASON 2–Comply With Your State’s Rules
Your LLC operating agreement defines the parameters of your business. Your LLC is bound by the default rules of your state if you do not have a written operating agreement in place. California’s LLC Act sets out default provisions that will govern the rights and obligations of the members. Your written operating agreement will override the California default LLC provisions.
Many provisions of the California Revised Uniform Limited Liability Company Act may be varied only in a written operating agreement. This allows the member or members to customize the structure and terms of the LLC to reflect their goals and agreements.
REASON 3–Document Your Terms
For an LLC with more than one member, clear documentation of the terms to which the members have agreed is essential. An oral agreement may lead to misunderstandings and difficulty of proof. Over time, members may have difficulty remembering even simple terms of an oral agreement. A complex oral agreement may be a lawsuit waiting to happen.
In addition, as your business gains momentum, you may want to hire a manager to take care of the day-to-day business operations so you can shift your attention to business development opportunities. An operating agreement can define the manager’s role—designating the authority and compensation and what happens if the manager leaves or competes with the company.
REASON 4–Clarify Succession
An operating agreement can specify what happens if you die or become unable to run the business. Without this specific provision, your family may have a hard time continuing the business or winding it down, or closing out the books.
Successful businesses grow. And growth requires capital. An operating agreement can specify how future investors will be treated. If you structure these terms in the operating agreement, the LLC will be better positioned in investment negotiations.
An operating agreement serves an important role, even for a single-member LLC. The LLC operating agreement puts you in the driver’s seat and enables the LLC to perform its main task—to limit liability.
If you have an operating agreement in place, we’d be happy to review the agreement, as well as your business, needs to ensure the operating agreement and your LLC are in sync. Or, if your LLC doesn’t have an operating agreement in place, we’ll work with you to craft an appropriate agreement.
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