Why do you need an Operating Agreement for an LLC?
The primary reasons for an Operating Agreement are simple. First of all, your state may require one. Second, if you are not in business alone, it's important to get financial, organizational, and operational details in writing. An Operating Agreement will define the rights and responsibilities of each principal of the LLC. It will also explain what happens if a principal decides to leave, including how a principal may transfer or sell their interest in the LLC.
Even if you don't have partners and your state doesn't require an Operating Agreement, it's still a good idea to have one. Having an Operating Agreement legitimizes your business, which provides further evidence that you keep your business and your personal life separate. Keeping your personal and your business affairs separate will help you avoid personal liability for things that go wrong on the business side of your life.
Having an Operating Agreement also prevents your business from being subject to your state's standard Operating Agreement, which may not be as beneficial for your particular business because it is a one-size-fits-all agreement.
Do all states require an Operating Agreement?
No, they do not. While some states do not require an Operating Agreement, it is still a good business practice to have an Operating Agreement in place when forming an LLC. While chances are you have a good relationship with those involved in forming your company, this could change as the reality of business ownership sets in and the day-to-day challenges of making decisions together become apparent. You should never depend on an informal agreement when you are starting a business.
What goes in an Operating Agreement if you have partners?
If you are the sole owner of an LLC, there are no specific agreements that need to be reached because you maintain exclusive control. However, if you have one or more partners, you will have to clarify several issues before you draw up your final Operating Agreement. Some of the issues you will want to clarify include:
- Division of Profits and Losses — Generally, this division is based on the amount each person has invested in the company. The profits and losses are reported on personal income taxes since the LLC is considered a pass-through entity.
- Rights and Responsibilities of Parties — Specifies the agreement the partners have reached regarding the day-to-day operation of the company. Also specifies whether there is a manager (versus an owner) appointed to carry out certain duties.
- Ownership Changes — How the partners will handle changes in ownership if one person decides they no longer want to be part of the company. This is important as it often involves a buyout.
- Conditions for Dissolution of LLC — Deciding what happens when the business is dissolved may seem like putting the cart before the horse, but it can prevent legal problems and headaches down the road. Consider how to handle assets, cash on hand, and debts if the LLC is ever dissolved, and do so before finalizing your Operating Agreement.
You should not depend on verbal agreements when forming a business because they are often unenforceable and there is no clear record of who agreed to what. Get your agreements in a signed and written document.
Are there specific requirements by state for Operating Agreements?
Limited Liability Company registrations are done on a state-by-state basis. However, unlike Articles of Incorporation, Operating Agreements do not get filed with the state, even in those states where they are required. Many states require you to have a Registered Agent and most have an annual report requirement. Make sure you have a clear understanding of your state's requirements for starting and maintaining an LLC so you are always in full compliance with the rules.
Do I need to hire a lawyer to draft an Operating Agreement?
When you are starting a business, you want to put your time, energy, and money into making it as successful as possible. Why hire an attorney to handle a basic task like drafting an Operating Agreement when you can make your own using an easily customized Operating Agreement? Rocket Lawyer documents are vetted by lawyers and legal staff so that you can use them with confidence. You can also ask a lawyer if you have legal questions about your Operating Agreement or your LLC.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.