An operating agreement is the basic written agreement between the members of a limited liability company (LLC). This agreement is a contract that controls your LLC’s operations as well as member interaction with other members and with the LLC as an entity.
The purpose of an operating agreement is to govern the internal operations of the business in a way that suits the specific needs of the business owner. You may think that an operating agreement is not necessary for your single-member LLC due to it essentially being an agreement with yourself. However, there are several reasons that your single member LLC will benefit by having an operating agreement in place.
Is the Operating Agreement a Legal Requirement?
North Carolina does not require an operating agreement in order to form a LLC but drafting one is highly recommended. There is no set requirement for the content of an operating agreement, but it typically includes processes for how meetings are conducted, how the company will be managed, what capital contributions are required from each member, and how profits and losses will be allocated. The operating agreement does not have to be filed with the state.
What Is Included in a Single Member LLC Operating Agreement?
The form and contents of operating agreements vary widely, but most operating agreements will contain six key sections: Organization, Management and Voting, Capital Contributions, Distributions, Membership Changes, and Dissolution.
• Organization. The first section of the operating agreement discusses the creation of the company. It covers when the company is created, who the members are, and the structure of the company. This section will also discuss the purpose of your LLC which can be generalized in case you wish to take on new business areas as well as the registered agent who will be responsible for receiving and taking care of documents received on the Company’s behalf. The last part of this section may discuss the length of time or “term” you want the LLC to be active. Unless there is a specific amount of time you wish for your LLC to exist, you can just state the duration as perpetual.
• Management and Voting. This section addresses how the company is managed and how the members vote. The company may be managed by the members or by one or more managers that are appointed by the members. The operating agreement will specify what authority the members have over company affairs. You can list yourself as the sole member and manager. The company may choose to make decisions through a voting process. Votes may be allocated to members in numerous ways. The operating agreement may specify what amount of votes is required for particular actions by the company.
• Capital Contributions. This section of the operating agreement covers which members have given money to start the LLC. It may also discuss how additional money will be raised by the members.
• Distributions. This section provides direction on how the company’s profits and losses are shared amount members, and how profits and losses will be accounted for and distributed. This section may also include who is responsible for the account and record-keeping of the LLC. The final item mentioned in this section may be a statement to limit the amount that you can be held financially responsible for in the case of a suit against the LLC.
• Membership Changes. The section of the operating agreement describes the processes put in place by the LLC to add or remove members. It also states if and when any members can transfer their ownership in the company. This includes how the company will handle changes if a member dies, goes bankrupt, divorces or is declared incompetent.
• Dissolution. The final section of the operating agreement will explain the circumstances in which the company may be or must be dissolved. This is sometimes called “winding up” the affairs of the company. You can also designate who will maintain control of the company in the event of your death or incompetency.
Operating agreements may also address other topics not mentioned above. This depends on the particular company. Members may wish to include requirement for meetings, restrictions on check signing, or explain how disputes within the company will be handled. Your operating agreement can be updated at any time and is not set in stone. It is always a good idea to create a formal, written operating agreement—even for a single-member LLC. Here are some reasons why:
REASON 1 – Avoid State-Imposed Default Rules
If your LLC has no operating agreement, the state’s default rules apply. Default rules are set by the state so that if a contract does not specify certain terms these rules will fill in any gaps. Default rules are made with the intention of allowing decisions that people would normally prefer, but sometimes they give businesses unwanted results. Having an operating agreement allows you decide how you want your business handled and overrides the default rules of the state.
REASON 2 – Maintain Control
Often as a business grows, an owner may want to bring in a manager to operate the daily operations of the business while the owner focuses on the bigger picture. An operating agreement is the perfect way for a sole member to define what a manager’s powers would be, how they would be compensated, and what happens if the manager leaves or competes with the company. An operating agreement binds managers and ensures that they remain loyal and financially responsible to the company.
REASON 3 – Keep Business and Personal Identities Separate
By having an operating agreement and keeping records of operations, you are able to establish the LLC as separate entity from the owner for liability and tax purposes. If you do not have an operating agreement, it will be more difficult to show that your business is separate from you. A major benefit of an LLC is that it limits liability by protecting a member from business liabilities and business assets from a member’s personal liabilities.
In order to keep this liability protection, personal affairs and business affairs need to be kept separate. This includes not combining personal and business funds and respecting various business formalities. If you do not keep your personal and business matters separate, then you run the risk of someone legally being able to get around your liability protections due to you not treating your business like a business.
An operating agreement is a key document for a LLC to show that your business operates as a legitimate company. Without an operating agreement, you run the risk of your LLC not being acknowledged as a separate entity, and another party being able to sue you personally instead of your LLC separately.
REASON 4 – Clarify Succession
An operating agreement clarifies what happens if the owner dies or is unable to run the business by creating a succession plan. Your operating agreement should include a clause stipulating who will manage the LLC if you are unable to do so. Without this provision, it could be difficult for your family to continue to the business or dispose of it without a time consuming and costly legal battle.
REASON 5 – Scalability
All successful businesses grow. An operating agreement can provide for how the investors will be treated, such as how their investments will be repaid, what types of voting rights they have, and what happens when investors want to leave the business. It is wise to plan for this at the beginning of forming your LLC so that future investors will not have as much negotiating power. Having your company already structured in a way that allows for growth will leave you in a more powerful position once your company begins to grow.
Let’s Continue this Conversation
An operating agreement serves an important purpose even for a single-member LLC. The operating agreement allows you to control important aspects of your LLC and allows the LLC to perform its most important task to limit liability.
Our attorneys have experience in reviewing and drafting Operating Agreements for LLCs and can assist you throughout the process. If you already have an Operating Agreement in place, our office can review your current document and advise you of any necessary changes to safeguard your business. If you are a single-member LLC that does not have an operating agreement in place, our office can go over your options and create an agreement that has the best interest of yourself and your company in mind.