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Pay now, or pay later. This is so true when forming a limited liability company (LLC) to run your business. After completing your state formation process, your LLC needs to have the right documentation in place. An operating agreement, sometimes called a company agreement, is a legal document that describes and outlines how an LLC will run, and is an essential document for owning and operating an LLC. Operating agreements are not required in most states; however, that should not dissuade you from creating one. Having an operating agreement can provide your business with many benefits and can help you avoid significant problems.

1. An operating agreement allows you to customize how your business operates. A key advantage of LLCs is the ability to create flexible business structures. However, when you fail to create an operating agreement, you subject your business to the default rules set out in your state’s LLC statute. On the other hand, if you draft an operating agreement, you can customize a variety of provisions related to the management and ownership of your business. LLC owners, referred to as members, can customize and identify

  • how profits and losses are split among members,

  • restrictions on the transfer of ownership interests,

  • methods for paying for business taxes, and

  • signatories for business accounts.

This is not an all-inclusive list. In general, most aspects of an LLC can be designed to reflect the members’ desires, unless the state statute that governs the LLC specifically prohibits contractual alteration of a specific right or duty.

2. An operating agreement may help maintain members’ limited liability. An important benefit of LLCs is that LLC members have limited liability—that is, they will not be held liable for the LLC’s obligations. However, limited liability may be lost if steps are not taken to maintain the business as an entity that is separate from its owners. One practical step is creating and implementing an operating agreement. Evidence that an LLC adheres to an operating agreement has supported the recognition of the limited liability of its members in the past. Steps to clarify the legal separation between business and owner are especially crucial for single-member LLCs, which have only one owner. When there is only one member, the limited liability veil is more easily pierced. Intentional planning, including the drafting of an operating agreement, is required to strengthen the shield and preserve the limited liability of the member.

3. An operating agreement identifies how decisions will be made. Another critical part of the operating agreement is the provisions that address how decisions are made. These clauses provide immense value, particularly for multimember LLCs and manager-managed LLCs, where multiple people may be involved in making management decisi