The Limited Liability Company is currently one of the most popular forms of business entity. It is easy to create, relatively inexpensive to maintain, and extremely versatile. However, single-member limited liability companies (SMLLC) face more scrutiny than multiple-member limited liability companies (MMLLC).

Why? Because individuals tend to treat these entities like a sole proprietorship, rather than the company it was intended to be. In doing so, this behavior puts all of the assets of the member at risk. Therefore, it is imperative to establish that the SMLLC is distinct from its member. In an SMLLC, you can do this two ways: (1) do not comingle business and personal funds and (2) have an operating agreement.

WHAT IS AN OPERATING AGREEMENT?

An operating agreement is a key document used by LLCs to outline the business' financial and functional decisions including rules, regulations, and provisions. The purpose of the document is to govern the internal operations of the business in a way that suits the specific needs of the business owners. An operating agreement is akin to corporate bylaws and is often required to open a bank account or obtain a line of credit from a financial institution. Operating agreements typically cover:

How to count the votes of the members
Division of powers between managers and members
Establishes how to admit new members
How to handle if a member wants to leave
How to handle the death or incapacity of a member
How the LLC should be taxed
How to handle distributions
Establishment of capital accounts
How to handle if a member wants to leave

WHY AN SMLLC SHOULD HAVE AN OPERATING AGREEMENT

There are five major reasons why it is a good idea for an SMLLC to invest in creating an operating agreement.

THE OPERATING AGREEMENT DESCRIBES THE COMPANY
As discussed above, the operating agreement describes the purpose and operations of the LLC, as well as the procedures to be followed in the business. The agreement states how funds are contributed and distributed to the owners.
IT SEPARATES THE BUSINESS FROM THE OWNER
By having an operating agreement and keeping records of the company operations, it helps to establish the separation of the business from the ownership, which is essential for liability and tax purposes.
AN OPERATING AGREEMENT CLARIFIES BUSINESS SUCCESSION
An operating agreement clarifies what happens to the business should the owner die or is incapacitated.
AN OPERATING AGREEMENT AVOIDS STATE LLC DEFAULT RULES
While only required by five states, if an LLC does not have an operating agreement, its state statute would apply as the “default rules” and determine how the LLC must operate. This is less than desirable and the member would miss an opportunity to truly determine how its business assets should be disposed of.
ESTABLISHES THE RULES OF ENGAGEMENT FOR ADDING NEW MEMBERS
The hope of every entrepreneur is that his or her business will scale, meaning that it can bring on additional members. A member saves itself a significant amount of time and money by determining how new members will be added and the rules they must abide by.

DEVOUGAS LAW GROUP CAN HELP YOU CRAFT YOUR OPERATING AGREEMENT

This is a high-level overview of the importance of operating agreements. While you can create your own operating agreement, you are better served by retaining the assistance of an attorney who can tailor your agreement to your needs and make sure all of the relevant clauses are included.

[Disclaimer: Nothing in this article constitutes legal advice. Please contact us in order to determine the appropriate course of action for your particular situation.]