An Operating Agreement is an agreement between the members of an LLC about how the affairs of the business will be handled. Many businesses, whether just starting out or fully established, may not realize they need an Operating Agreement. Here are the top 5 reasons every LLC should have an operating agreement:
1. Death, Divorce, and Disability
Nobody wants to believe that their marriage will end or that something will happen to cause them to be permanently disabled. Unfortunately, things like this happen every day. While divorce and disability may not be as much of a certainty in life as death and taxes, entrepreneurs should be protecting their business from all of these things. An Operating Agreement can stipulate what happens in the event that a member dies, divorces, or is permanently disabled and is no longer able to maintain the business. The default rules in Louisiana are not favorable to LLC’s in these situations, and it is important that these issues be proactively addressed to protect the integrity of the business.
2. Audit Protection
Speaking of taxes, there is certain language dealing with Capital Accounts that your attorney will probably want to include in your Operating Agreement. Although it may sound like gibberish to someone outside of the tax or legal fields, these provisions can provide an extra layer of protection for your business in case it is ever audited by the IRS.
At the beginning of a business when the members are reveling in their great idea and good fortune to come, it may be difficult to imagine ever disagreeing. Particularly in family businesses, there may be a temptation to forego an Operating Agreement because everyone gets along and agrees about everything…well, at least until they don’t. People disagree over things every day, all the time. There are a lot of decisions that go into running a business, and if there is a dispute among the decision makers (either the members if the LLC is member-managed or the managers if the LLC is manager-managed), your Operating Agreement can dictate how disputes will be settled. By working together up front to agree on how to handle conflict, and including these provisions in the Operating Agreement, members can hopefully avoid costly litigation down the road.
4. Secures Limited Liability
The Operating Agreement is one example of a corporate formality that courts look to in determining whether you are running a legitimate business that warrants limited liability. While you should talk with your lawyer about other important corporate formalities that can help prevent courts from piercing the corporate veil and holding you personally liable for the company’s debt (or a judgment), the Operating Agreement is one corporate formality that should not be overlooked.
5. Clarifies Expectations
Finally, by creating a system and structure for managing the LLC, the Operating Agreement clarifies the members’ expectations and puts it in writing for everyone to see. By increasing communication and clarifying expectations on the front end, the Operating Agreement is a powerful tool for reducing conflict among the business’s owners in the long run.
Allen & Gooch is providing this legal update for informational purposes only. This article should not be construed as legal advice or a legal opinion as to any specific facts or circumstances. You should consult your own attorney concerning your particular situation and any specific legal questions you may have.