Updated: Mar 31
An operating agreement is the blueprint for how your business operates. In a business with two or more members, it’s easy to understand why an operating agreement is necessary. Common issues include what happens when disputes arise between members, how membership interests can be transferred and who runs the business. None of these are issues for the single member LLC so an operating agreement makes no sense, right? Here are three reasons why that’s wrong.
Without an Operating Agreement, your Limited Liability Status is Jeopardized
Most of my clients who want to form an LLC want the protection it provides their personal assets from the debts and obligations of the business. This limited liability is not “automatic”. An LLC must earn this limited liability. This means that an LLC must be treated as a separate entity from the business owner. Creditors who try to avoid this liability protection — known as “piercing the veil” – argue that the LLC and owner are not two separate entities, but one and the same in which the owner is treating the LLC assets as his own, similar to a sole proprietorship. The owner can fight back by producing a valid operating agreement for the LLC as proof that the LLC is truly a separate legal entity.
An Operating Agreement is Necessary to Do Business with Others
An active LLC will need to deal with potential lenders, creditors, taxing authorities and other persons in order to successfully carry on its business. All of these persons are likely from time to time to ask individuals who are members of single-member LLCs for legally valid documentation concerning, for example, the identities of persons with authority to bind their LLCs and concerning the tax and financial structures of these LLCs. Written operating agreements provide this documentation
Without an Operating Agreement, your LLC is Bound by the Default Rules of your State
We all know how business tends to go when the government is the one calling the shots. It’s not pretty. LLC acts are written primarily for multi-member LLCs, and many of their mandatory and default provisions are inappropriate for single-member LLCs whose members are individuals. Luckily, most state laws governing LLCs allow the default rules to be overwritten in the company’s operating agreement. Going without an operating agreement is like having no last will and testament. Do you want the government deciding how your estate will be administered and distributed upon your death? No. Don’t let the government set the rules for your LLC.
If you used an internet service to form your LLC, you probably did not prepare an operating agreement. Even if you did, its probably a “one-size-fits-all” type. That’s not much better than relying on the LLC Act.