So, yesterday, we spoke about the differences between sole proprietorships and single-member LLC’s (aka, disregarded entities).   And, I said I would explain today why an operating agreement is not a useless frill, but a necessary document for LLC’s to have and use.

The operating agreement sets the rules for how the entity is structured and how it operates.  And, if this LLC has more than one member, it explains the relationships and rules for the members of this multi-member LLC.

The Operating Agreement (sometimes called the LLC agreement) attempts to solve any issue that may arise during the life of the LLC.  While state regulations may cover some of these issues, the Operating Agreement can override those provisions, allowing the LLC to operate the way the members desire (as long as those wishes are legally endowed).  The agreement, once signed, is the business bible- but it never has to be filed with the state authorities; it’s just for the business management and members (i.e, private).

Too many of our clients argue that they already have such a document.  That’s because they are confused with the benign “Articles of Organization” that the state or commonwealth requires to create an LLC with an operating agreement.  Those Articles of Organization only set up the business name, the name of the registered agent (and his/her/its address), and maybe one or two other factors.  But, it does not address the management or operations of the business.

And, most states require an Operating Agreement,  but they have lax oversight.  They may even say the agreement can be oral or implied.  (Yeah, that means non-existent.)  But, that also means that whatever rules and regulations the state of authority impose- they are what you must always follow.  And, you can bet your state or commonwealth will change the laws during the life of your business.

And, you can bet the oral or implied rules won’t help when you run short of cash (like what happened during the pandemic) and you want each member to pony up some cash to tide the business over. Or, when, y’all made a mistake and the IRS wants significant change from you.  (Consider the most common failing of LLC’s- failure to file Form 1065 in a timely fashion.  The fine for not filing on time?  $ 190 per month per member!)

The chart below lists the salient features that should be addressed in the operating agreement.  You should also note that missing information and instructions has consequences. Those missing details can leave the business vulnerable to legal trouble; more often than not, the missing information becomes a source of conflict among the members.  Lacking detailed instructions as to how one resolves disagreements either leads to the termination of the entity or to very costly litigation.

We suggest that besides retaining the original  signed document in the corporate records, each member of the LLC retain a copy.  And, the documents need to be reviewed (annually?  Every 2 years?) to ensure that the members’ concerns are addressed- and to be in compliance with any changes in state laws.  (As an example, we have a 5 minute review of the highlights of our operating agreement every end-of year meeting.)

Now, let’s grow our businesses!

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