4 Reasons Your Limited Liability Company (LLC) Needs an Operating Agreement

Starting a business with someone else is a tricky endeavor. While things may seem promising now, conflicts and disagreements in the course of your partnership could really take a toll on the company. Having an operating agreement is a great way to protect yourselves and avoid losing everything you have been working for. Here are a few reasons your business needs an operating agreement.

1. To Avoid Default Statutory Provisions

Different states have different statutes governing LLCs, but most are not in line with operating agreements. Some of the provisions of the statute are only applied when there is no operating agreement. The quandary is that these provisions are not always ideal and may lead to different outcomes than intended.

For example, cash dividends and other assets could be shared equally among all members if there is no operating agreement indicating how these items should be allocated. The same goes for voting rights. A member who only contributed 4% of the capital to start the company could have equal power in decision making and claim 50% of the profits in the absence of an operating agreement.

2. To Separate the Company From Its Owner(s)

If you are running an LLC (limited liability company), it means that you are not personally responsible for its debts and liabilities. However, to ensure that this protection holds up, you need to maintain a certain level of formality and completely separate the company’s operations and assets from all the owners’ accounts and activities. A valid operating agreement is a great way to show this formality.

3. To Prepare for Future Misunderstandings in Advance

Whatever type of relationship you have with the other members of your company, it is always advisable to have as many contingencies as possible in the event of future disputes, misunderstandings, or unexpected events. For example, suppose something happens and one of the members decides to leave the company, or one of you incurs severe physical or mental illness that significantly reduces your input. In this case, an operating agreement can help to address these scenarios. You may also want to consult a lawyer who is experienced with operating agreements for advice on which types of situations to prepare for.

4. To Protect Against Unintended Consequences

Apart from creating a sense of formality and separation in your LLC, an operating agreement can also protect you against unintended consequences. Suppose, for instance, that members of a member-managed LLC are deadlocked on a company decision which would result in irreparable injury suffered by the LLC. When faced with such deadlock, under the LLC Act, a member of that LLC may seek judicial dissolution of the LLC.

The company can avoid an unwanted judicial dissolution by inclusion of a “deadlock sale provision” in the company’s LLC operating agreement. Such provision could resolve the deadlock through a number of mechanisms including a buy-sell provision or an LLC governance change. By including a deadlock sale provision, a company faced with a deadlock could avoid costly litigation and the many unintended consequences that could come with that litigation.

Running an LLC is not entirely as smooth as it sounds on paper. There are several legalities to adhere to and important documents to maintain to ensure that the company runs as seamlessly as possible. If you need any legal assistance in creating an operating agreement or any other document, R|A Law has got you covered.

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