Do I Need an Operating Agreement for My LLC?

Many entrepreneurs are understandably eager to get their LLCs off the ground. After all, the sooner business begins the better. Which leads many LLC members to ask: Do I really need to write an operating agreement?

Fair enough. No one wants to compose a lengthy, complicated legal document if it isn't necessary. Sometimes this question comes with a variation: I'm starting a single-member LLC, so why would I need an operating agreement? It's just me.

The truth: Every LLC needs an operating agreement (especially a single-member LLC). That's the short answer. Here's the why:

5 reasons your LLC needs an operating agreement

1. An operating agreement defines

There are numerous roles in the management of a company. Regardless of what they are called in your LLC, someone must take on the various roles associated with the company president, secretary, treasurer, etc. While most business owners have a fair idea of what these roles entail, the operating agreement takes the implicit and makes it explicit. All roles are clearly, thoroughly defined.

By defining roles, you effectively establish order. This job belongs to Joe. this job belongs to Sue. The last thing you need is to discover nobody opened the company bank account because it was unclear who was responsible for opening new accounts.

2. An operating agreement avoids future conflict

When roles are clearly defined, every LLC member knows precisely what is expected of them. Each member can do their job with complete confidence, knowing they are fulfilling their roles. Murky, undefined roles lead to conflict. Joe believes he's doing his job, but Sue believes he's overstepping his bounds and trying to do hers. No one knows for sure who is in charge of what. This leads to resentment and dissatisfaction.

Everyone wants to be appreciated for their contribution to the company. Make sure roles are clear, and everyone can get the credit they deserve.

3. An operating agreement plans for dissolution

Think of your LLC as a person. What happens when someone dies? The individual's family must distribute the person's assets. To do so, the family follows that loved one's will.

But what happens when there's no will? Two words: probate court.

An LLC is no different. If your LLC dissolves minus an operating agreement, then the company's assets go to probate court. Without a dissolution plan, the court will divide up the assets according to state law. While state laws attempt to be fair, it is unlikely your LLC members will be satisfied with assets divided by the court.

When writing your operating agreement, lay out a clear plan for how assets will be divided and how business will be properly wound up.

4. An operating agreement supports liability protection

Every LLC member's fear is the threat of a court “piercing the corporate veil” and seizing a member's private assets. When this happens, it is often because the LLC can't demonstrate a clear separation between members and the LLC--this is a particular danger for single-member LLCs.

An operating agreement alone is not evidence of separation, but it is a crucial part of the overall package. Should you ever end up in a legal dispute in which you need to prove separation, the judge will want to see as much physical evidence as possible.

An operating agreement is often referred to as an LLC's blueprint. You write one in order to plan your business, the same way an architect writes a blueprint to plan a house. Just as you would be skeptical of a contractor building your home without a plan, it is unlikely that a judge will look favorably upon your LLC if you never took the time to write an operating agreement.

5. An operating agreement aids investment

Every company has investors. Even in the smallest LLC, the initial members must give something in order to get the company going. Most LLCs will need business loans, and some companies may even court venture capital.

No matter who is investing in your business, they will want to feel secure in their investment. And while many investors are persuaded by good business proposals, few will offer their money without evidence that your LLC is well-thought-out and organized.

An LLC without an operating agreement shows a lack of preparation and a lack of seriousness. If your bank sees your LLC as disorganized and unprepared, it will be difficult to convince them to extend your company a loan.

Don't just have a dream for your company, have a plan. Show investors that you are as interested in the nitty-gritty practicalities as you are in your lofty ideas. Writing an operating agreement goes a long way in convincing investors to take your LLC seriously.