Your LLC needs a written operating agreement

You have a great idea for a new business and have formed a limited liability company, an LLC.  While corporations are required by state law to have bylaws, LLCs are not required to have written operating agreement.  However, whether you are the only member of the LLC, or there are two or more members, you should have a written operating agreement. Why?  Here are five good reasons:

• LLC’s are very popular ways to set up a business because of their flexibility compared to corporations. An operating agreement lets you set out how the LLC will be managed, subject to some limits in state LLC law.  Without a written operating agreement, everything defaults to the state law, and you may not want to be limited in some of the ways the state law requires, such as who can make decisions for the company.

• An important reason to form an LLC is to protect your personal assets—your home, bank accounts, etc.—from liability. If you are the only member of the LLC, a written operating agreement helps to establish the LLC as a separate legal entity from you personally. This acts to reinforce the liability shield that the LLC provides.  If you create an LLC but then don’t treat it as a separate entity (for example, you don’t keep separate bank accounts for the LLC), then someone filing a lawsuit, or some other creditor, may be able to reach your personal assets by arguing that the LLC is just a sham.

• If the LLC has more than one member, the operating agreement sets out management responsibilities. Without this, members may disagree on how to manage the LLC, resulting in serious conflicts that can damage the business.

• Under federal law, a multi-member LLC is taxed as a partnership. While income and losses still flow through to the members, with a written operating agreement you can vary many of the default provisions of partnership tax law, such as allocation of profits and losses. It also can set forth how and when profit distributions will be made.

• If an LLC makes a profit, the IRS still requires the members to pay tax on those profits even if the doesn’t distribute those funds to the members. A written operating agreement can require the LLC to pay enough to members to cover those taxes, while still retaining some earnings.  Without a written operating agreement, some members may not agree to this (for some reason), and then all of the members will have to find the money elsewhere to cover their tax bill.

There are other reasons why an operating agreement is critical to the long-term health of an LLC, but these are just a few of the more important ones.  If you form an LLC, make sure to have a written operating agreement!