4 Reasons Why a Single Member LLC Needs an Operating Agreement - dummies

4 Reasons Why a Single Member LLC Needs an Operating Agreement

By Jennifer Reuting

An operating agreement is a contract that controls how an LLC (limited liability company) operates and how the members interact with the LLC. You might think that as a sole owner of a company that no operating agreement is necessary — after all, operating agreements are comprised of terms agreed to by all of the members, and well, why make an agreement with yourself?

  • Reason 1: 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. Luckily, most state laws governing LLCs allow the default rules to be overwritten in the company’s operating agreement.

    Now, the states vary substantially on what can or cannot be amended in your company’s operating agreement. Do some research before drafting your operating agreement to make sure that the terms you’re putting into place for yourself are even legal in your state.

    To make the state-specific research much easier for you, check out this password-protected site just for Dummies readers that lists a lot of the important laws governing LLCs in every state. You can sign in at www.docrun.com/dummies (password is onesmartdummy).

  • Reason 2: The alter ego problem — you must separate the business from the individual.

    A major benefit of an LLC is that it limits liability in two ways. First, it protects the member from lawsuits that arise from the business of the LLC. Second, it protects the LLC from the personal liability of the member.

    Without an operating agreement — which states that the LLC is an independent business, what the business does, and when the business was formed — the business looks a lot like a sole-proprietorship, which has no liability protection. In other words, it’s really no different than good ole you. The danger of this lies in the fact that the courts will not recognize that your LLC is its own entity (or “person,” so to speak) and will not allow you all of the great liability protection advantages that an LLC offers.

  • Reason 3: You can allow for future growth.

    All successful businesses have something in common: They grow! For example, a business might want to take on investors in order to expand. An operating agreement can provide for how the investors will be treated, such as how their investment will be repaid, what voting rights the investors will have in the company, and what happens when the investors want to “cash out” of the business.

    If you know what you want, then it’s good to get this all structured up front. Especially if you aren’t interested in giving future investors too much wiggle room in the negotiations. Having your company already structured in a way that allows for explosive growth will definitely put you in a much more powerful position come fundraising time.

  • Reason 4: You can control the day-to-day operations.

    Often, a business owner wants to bring in a manager to operate the business while the owner can concentrate on big-picture thinking. An operating agreement is the perfect place for a sole member to define what powers a manager will have, how he or she will be compensated, and what happens if the person leaves the company. The agreement binds the managers and ensures that they are loyal and financially responsible to the company.

As you can see, it is very important for a single member LLC to have an operating agreement. Luckily, you won’t have to worry about fighting over terms and getting everyone to sign. All the more reason to draft your operating agreement today!