A Limited Liability Company (LLC) is a hybrid business structure that combines some of the benefits of a corporation with the flexibility of a sole proprietorship or general business partnership.
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The strength of an LLC is largely based on the manner in which it is created – and the devil is always in the details.
LLC operating agreements flesh out the details associated with the formation of a limited liability company. The idea is to create an agreement that produces a legal foundation for the LLC structure and protects the ownership interests of LLC members. It's a common misperception that single owner LLCs don't need an operating agreement. But in fact, there are several reasons why single owner LLCs need an operating agreement even more than multi-owner LLCs. Whether you're a single owner or multi-owner small business, here's what you need to know about LLC operating agreements.
LLC Operating Agreement Overview
LLC operating agreements protect your company in several important ways. Right out of the gate, an operating agreement clarifies your business structure. Without an operating agreement, a single owner business can have a difficult time proving they are an LLC and not a sole proprietorship. Operating agreements also describe ownership interests, profit divisions, lines of authority and other critical elements in a multi-owner business.
Operating Agreement Content
There are several issues that need to be addressed in a sound LLC operating agreement. Ownership shares are a central component of the document. Owner percentages are allocated according the resources (cash, material property, skills/services) each partner invests in the business. Ownership percentages also affect the percentage of profit (or distributive shares) each partner receives from the business.
Another area that needs to be addressed in the operating agreement has to do with the decision making process and ongoing operation of the LLC. Partner responsibilities should be clearly described as well as topics like voting rights, business meetings and day-to-day management activities. Finally, a healthy LLC operating agreement will discuss the subject of owner transitions. This is especially relevant for a multi-owner LLC in which one or more partners will eventually leave the business, creating the need for a buyout.
- Tips & Guidelines
- If topics aren't properly addressed in the operating agreement, many states apply "default" rules that may not be beneficial to your business.
- We strongly encourage LLCs to consult an attorney during the drafting of the LLC operating agreement because even small oversights can have big consequences down the road.