Starting a Small Business: Does my LLC Need an Operating Agreement?

An Operating Agreement is an agreement among the members of a limited liability company (an “LLC”) which governs how the LLC will operate.  It also contains general procedures as well as member’s financial and managerial rights and duties.

In Ohio, LLCs are governed by the default rules set forth Ohio Revised Code Chapter 1705.  In Michigan, the applicable rules are found in MCL 450.4101 et seq.  Operating Agreements help you guard your limited liability status, head off financial and management disputes, and ensure that your business is governed by your own rules rather than your state’s default rules.  Thus, it is strongly recommended that your LLC have one.  Here are a few of their main benefits:

  1. Operating Agreements protect your LLC’s limited liability status.  In single member LLCs, an operating agreement is a declaration of the structure that the member has chosen for the company and sometimes used to prove (in court or with the IRS) that the LLC structure is separate from that of the individual owner.  An Operating Agreement is necessary documentation that the owner is separate from the entity itself.  In fact, many states, including Michigan, have laws saying that an operating agreement for a single-member LLC is not invalid simply because only one individual signed the document.
  2. Operating Agreements define the LLC’s financial and management structure.  It is essential for multi-member LLCs to document their profit-sharing and decision-making protocols as well as their procedures for handling the additions of and departure of members.  Without an Operating Agreement, even the smallest financial and managerial disputes can cripple your LLC.
  3. Operating Agreements override default rules imposed by a state’s LLC Act.  In order to do so, an Operating Agreement generally addresses the following things:  the initial members of the LLC; the members’ percentage interests in the business; the allocation of profits and losses among members; the capital contributions of members; the members’ voting power; and rules for holding meetings and taking votes; and “buy-sell” provisions, which set out rules for what to do when a member wants to sell his or her interest, dies, or becomes disabled.

This internal agreement, which is agreed upon by the company members, contains provisions for critical rules and provisions relating to how the company is run.  So if you live in Ohio or Michigan and have an LLC, it would be foolish not to protect yourself and your business with an Operating Agreement.