A limited liability company (LLC) provides the liability protection granted to corporations without retaining the benefits of a partnership. Articles of organization filed with the state make an LLC official but do not elaborate on day-to-day functions. One document—a written operating agreement—contains provisions on issues ranging from membership and tax treatment to management structure and dissolution. Although required by law in only five states, an operating agreement can almost single-handedly determine whether an LLC can succeed and thrive in the marketplace.
Why should an LLC create an operating agreement?
An operating agreement serves as a contract between its owners (members). As such, the document will specify and clarify fundamental duties among members and between themselves and the LLC. The primary issues include:
- Basic Information: LLC’s official name, duration, statement of purpose and registered agent
- Member Information: Describes members’ roles within the business, amount of their contributions and how to apportion their profits
- Management Structure: Identifies the LLC as member-managed or manager-managed
- Operating Procedures: Details issues of holding member meetings, voting rights, adding new members and dissolution
- Tax Treatment: Explains how the LLC may change tax classification from its default status to filing as an S-corporation or C-corporation
How does an operating agreement benefit an LLC?
In the absence of an agreement, state law would resolve many, if not most of these issues, especially in the case of dissolution. The agreement affords members incredible flexibility to establish mutually agreeable terms, as well as change them should circumstances compel them. Other advantages include:
Strengthens Legal Separation: A written agreement, which would likely include a liability statement, will establish a legal distinction between the business and its members.
Establishes a Central Agreement: Issues members will address, whether in the short-term, e.g., compensation, or long-term ownership, may change with time but provide no reference point from which to establish a legal claim.
As the most popular form of organization chosen by small business owners, an LLC requires diligent planning and a willingness to forecast for the worst-case scenario. State laws regarding business entities may change, yet human nature remains predictable. An attorney who understands how the two intersect can offer guidance.