The Limited Liability Company (LLC) is one of the more common forms of business ownership for small business owners.
LLCs offer flexibility, can provide asset protection, and in some cases, might provide tax advantages for a small business owner.
LLCs can also use either a partnership or corporation (S Corp or C Corp) for their taxation method with the IRS.
We often get asked the question, “Do I need to have an Operating Agreement with my LLC?”
The pure attorney answer to this question might always be “yes, just to be safe,” but we feel that the better answer can really depend on a few key items.
What is an Operating Agreement and what does it do?
A LLC Operating Agreement is a legal document that usually establishes the rights and responsibilities of the different owners of the LLC, commonly known as LLC Members.
The LLC Operating Agreement typically provides guidance on:
- How the LLC’s internal management is designed to work,
- How LLC decisions are to be made,
- How the LLC could expand, or dissolve, in the future,
- How LLC Members can change their ownership levels, and
- Many other items that generally provide structure for the business entity.
The LLC Operating Agreement is an internal document and is rarely filed with the state or other governmental groups. The LLC Operating Agreement is not a legal requirement for filing a LLC with most states, including Missouri and Kansas.
2 Unique LLC Situations That Need Consideration
- Single-Member LLCs
- Husband/Wife LLCs
1. Does a Single-Member LLC need an Operating Agreement?
When that question comes up I often ask the business owner, “Now, who are you really making this agreement with? Since there is only one LLC Member with a Single-Member LLC, I guess the agreement would be with yourself.”
In all seriousness, this is where most business owners do not spend much time worrying about creating an LLC Operating Agreement.
There is no legal requirement to create one, most people do not create agreements with themselves, and typically the small business owner just doesn’t have time for unnecessary overhead expenses.
If a Single-Member LLC wants to show structure and processes for a potential buyer, or investor, then perhaps it has value, but most Single-Member LLCs do not create an Operating Agreement.
I am always amazed how many banks still ask for a copy of an Operating Agreement with Single-Member LLCs, but usually we can work through those requests without drafting one.
2. Does a “Husband and Wife LLC” need an Operating Agreement?
This question is a little more complicated than the situation above, because TWO people are involved AND they are also married.
In today’s high-divorce-rate world, a few variables are involved when answering this question. And it’s also good to consider that many unmarried partners would benefit from asking similar questions.
Again, the state does not require a LLC Operating Agreement, but the couple really needs to ask themselves whether they need a written LLC Operating Agreement to manage how they will run their business.
Often that question is answered with a, “No, we don’t need one because we’re married,” but further “what if” questions need to be asked and considered:
- What if we get a divorce or separation? How would this impact our business?
- What if one of us passes away or becomes disabled? How would ownership continue for the business?
- What if the two LLC Members are investing significant individual assets acquired prior to the marriage/relationship?
- What if the marriage is a classic Brady Bunch couple with multiple grown children from each spouse? Does this change the need for a LLC Operating Agreement?
Again, do not be surprised if a bank asks for a copy of the LLC Operating Agreement. If the LLC is trying to get a loan, the loan provider will often require a LLC Operating Agreement.
In the end, LLC Members have to answer the question on whether they create a LLC Operating Agreement. Generally, there are plenty of reasons for a married couple to have an Operating Agreement, especially compared to Single-Member LLCs.
Whenever two or more people are forming a LLC, we highly recommend they create a LLC Operating Agreement.
Our Rationale for Creating Operating Agreements
The decision is always up to LLC Members, but not having a LLC Operating Agreement often creates too much risk and exposes the LLC Members’ individual investments in the business.
We often hear, “but we are close friends” or “we are family” or “we can work everything out,” along with plenty of other reasons people give for not wanting to create an Operating Agreement. However, these reasons can usually be translated into one thing:
“We really don’t want to take the time and face the tough decisions we’d have to make to create an Operating Agreement.”
When two or more people are involved in a business endeavor, it’s best if tough decisions can be made during calm times. Creating an Operating Agreement forces business owners to think through and communicate with each other while the stakes are relatively low. And we feel, despite how hard this can be, that it is rarely time wasted.
Most importantly, this means that business owners can reach an agreement BEFORE a complicated situation arises, so everyone involved can understand how to handle the issues that come up. Operating Agreements can be changed in the future, but a business will really benefit when this structure is clearly defined in advance.
Additionally, banks and other vendors will most likely require an Operating Agreement just to manage their business risk in working with the LLC.
One thing is certain, when money or other assets become involved, many friendships and/or family relationships are at risk in the absence of an Operating Agreement.
Business Planning With The Bell Law Firm
As a part of our Business Planning focus, The Bell Law Firm creates:
- LLC Operating Agreements
- Corporation Shareholder Agreements (similar to LLC Operating Agreements),
- Corporate Bylaws, and
- Other beneficial formation documents.
Many of the issues with these agreements are complex and involve negotiation and compromise between business owners, but they are part of creating a valuable long-term structure for the business. As businesses grow, these agreements become increasingly important as guiding foundations for the business entity.
We help in many ways throughout the process, but three of the most important things we do are as follows:
- We help identify key issues for the business owners to review and discuss.
- We help facilitate the discussion to reach agreement on these issues.
- We document all of the items and create an agreement from them.
Creating an Operating Agreement is certainly an investment for the business, but when it is done right the agreements provide enduring value and critical structure to the business entity.
If you have questions about creating LLC Operating Agreements, or any related business agreements, please give us a call at 913-345-2323. We will be happy to help.