You formed an LLC, Should You Have an Operating Agreement?

All LLC’s with two or more members should have an operating agreement. Although this document is not required for a single member LLC, it’s a good idea in any case.

An operating agreement sets forth the rights and duties of the members of the LLC and provides guidelines for its operation.  It deals with capital contributions, allocations and distributions, management, membership notice, and voting rights, transfer of membership interests, dissolution and winding up and other important matters. LLC can be either managed by the member owners, much like a general partnership, or it can be structured to be managed by a manager, subject only to the general review and confirmation of the members.

It is recommended to have an operating agreement for the following reasons. First, the operating agreement describes the operation of the LLC clarifying how funds are contributed or distributed to the owner; hence it is a good way to assure appropriate records are kept. Second, having an operating agreement and keeping records of operations helps establish the separateness of the business from the owner for liability and tax purposes. If you don’t have an operating agreement, you will find it more difficult to show that your business is separate from you. This is crucial, particularly if there is a liability issue. Third, an operating agreement also clarifies what happens if the owner dies or is unable to run the business.; that is, it creates a succession plan. Your operating agreement should include a clause stipulating who will manage the LLC if you are unable to do so. Without this specific provision, it may be difficult for your family to continue the business or dispose of it without a lengthy legal battle. Finally, an operating agreement helps avoid default rules of the California Codes of Corporation, which would govern if you don’t have set forth the conditions. In other words, without the operating agreement you run the risk of having the state tell you how to dispose of your business assets or otherwise run it which may not be what you want.

By Dorisa S. Hanrahan, Esq.

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