WHY SHOULD SMALL BUSINESSES CARE ABOUT CUSTOMIZING THEIR LLC OPERATING AGREEMENTS?

Starting a new business is an exciting venture, but it comes with many important decisions. One of the most common structures for small businesses is the limited liability company, or LLC. If you’ve chosen this path, one of the most vital governing documents is an LLC agreement, also known as an operating agreement. While it may sound like complex legal jargon, this agreement is a practical tool that guides how your business runs and outlines the rights and responsibilities of its owners.

Many small business owners, especially in states where it isn’t mandatory, either skip this step or use a generic template for an LLC operating agreement. This can be a costly mistake. A vague or nonexistent operating agreement can lead to future conflicts over management and member responsibilities. It provides a roadmap for your business, allowing you to define rules that suit your specific needs rather than defaulting to standard state regulations.

This guide will explain what an LLC operating agreement is, why it’s so important (even for single-person companies), and what key components you need to include. Understanding these elements will help you create a solid foundation for your business, ensuring clarity and protection for everyone involved.

What is an LLC Operating Agreement?

An LLC operating agreement is a legal document that details the ownership structure and operational rules of your company. Think of it as a user manual for your business. It outlines the duties and responsibilities of the members, the handling of profits and losses, and the procedures for making crucial decisions.

For businesses with multiple owners, this agreement acts as a binding contract between all members, helping to prevent and resolve disputes. But even single owners benefit immensely from having one. An operating agreement helps prove that your personal and business affairs are separate. This separation is necessary to preserve the liability protection that makes an LLC so attractive. Without it, a court could potentially “pierce the corporate veil,” making you personally responsible for the company’s debts and legal liabilities.

Unlike other formation documents like the articles of organization, operating agreements are typically kept confidential and do not need to be filed with the state.

What’s Included in an Operating Agreement?

Although no two operating agreements are identical, they typically include a standard set of basic information as outlined below:

• Official LLC Name: The registered name of your company.
• Principal Place of Business: The main address where your business operates.
• Duration: Whether the LLC will exist indefinitely or for a set period.
• Statement of Purpose: A brief description of your business’s activities.
• Registered Agent: The person or service designated to receive official legal and state documents.
• Owners’ Details: Names and addresses of all members and contributions.

Besides this basic information, the operating agreement should also establish specific information about management and members rights and responsibilities tailored to the business needs and owners’ purposes. Usually, people overlook this specific information mentioned below or draft it in a generic manner, which can lead to numerous future problems.

• Voting Rights: How votes are distributed among members.
• Decision-Making: The process for approving major actions and daily decisions.
• Meetings: Guidelines for holding and conducting member meetings.
• Adding Members: The process for bringing new members to the LLC. How is the approval, the requirements? Are any rights guaranteed to members, such as the right of first refusal?
• Removing Members: The process for handling a member’s exit.
• Dissolution: The steps to take if the business needs to be closed down.
• Owner’s Death: What happens to a member’s ownership stake if they pass away or decide to leave the business?
• Owner’s Withdrawal: Is it possible for a member to leave the LLC? And if this could happen, what happens to a member’s ownership if it decides to leave the business?
• Dispute Resolution: The agreed-upon process for resolving conflicts between members in the jurisdiction that makes sense for the business.
• Amendments: The procedure for approving changes to the operating agreement itself.
• Preferred Tax Treatment: LLCs offer unique flexibility in how they are taxed. By default, profits “pass through” to the owners and are only taxed on their personal income tax returns. However, some LLCs may find it beneficial to be taxed as an S-corp or a C-corp. Your operating agreement should state your LLC’s initial tax status and outline the process for changing it in the future if needed.

Build a Strong Foundation for Your Business

A well-drafted operating agreement tries to plan for the unexpected. These additional clauses can help navigate difficult situations smoothly. Creating an LLC operating agreement might seem like a daunting task, but it’s a way to set your business up for success. This document provides the clarity, structure, and protection needed to run your company effectively and prevent future conflicts. By having a customized operating agreement for your business needs, you create a solid foundation that allows you to focus on what truly matters: growing your business. For assistance in reviewing or drafting operating agreements, please contact Luzzi Law Firm (melissaluzzi(at)luzzi-law(dotted)com).

This information is intended to inform firm clients and friends about important matters for businesses. Nothing in this article should be construed as legal advice or a legal opinion, and readers should not act upon the information contained in herein without seeking the advice of legal counsel.