Tricia Dunlap Esq.
~4 minute readIf your small business is structured as a limited liability company (LLC), then the cornerstone of your success is a well-written and signed operating agreement (OA). Single member LLCs are no exception. This post is #2 in our LLC Education Series:
- What Exactly IS a LLC, Anyway?
- Operating Agreements – Essential to Your Success
- The Perilous Position of Minority Members
- Hotel California: You Can Checkout, But You Can Never Leave
- Fiduciary Duties: The Responsibilities You Never Knew You Had
What is a LLC Operating Agreement?An OA is a written agreement among the LLCs members that governs (i) your obligations to one another and (ii) how the LLC will conduct its business. Without an OA, Virginia’s Limited Liability Company Act (the “Act”) will govern the conduct of the LLC and any disputes among members. By design, the Act’s protections are bare bones. If you intend to be in business for longer than a hot minute, the Act is unlikely to give you the protection or structure you need. LLCs are creatures of contract (for more on that, go here) – their purpose is to provide a highly flexible, easy to govern, and lightly regulated business relationship that limits the liability of its owner(s) (called “members” in LLC-speak). The Act’s regulatory light touch can be very beneficial but, as with any freedom, without thoughtful planning it is easy to build a business on a shaky foundation.
The Operating Agreement: Write It Down and Sign ItBelieve it or not, the Act does not require a LLC to have an OA and OA’s don’t need to be written down or signed by members. Remember I just pointed out that the Act is a “light touch”? Well, that’s one example. The trouble is, without a written and signed OA, other members or outsiders could claim that an oral OA or a written but unsigned OA exists. Consider, for example, one member’s heir claiming to have found an unsigned OA that assigns the dead member’s interest to the heir. A well written and signed OA would prevent that from happening.
Even Single-Member LLC’s Need an Operating AgreementYou are the only member of your LLC, but you still need an operating agreement. Most likely, the reason you’re doing business as a LLC is to limit your personal liability but without a written and signed OA, courts may not recognize your LLC as a distinct entity. This is especially true if you co-mingle your personal finances and your LLC finances. The liability shield you think you have may be an illusion. Also, for single-member LLCs the Act has a very broad definition of what could constitute an OA:
- Any writing the member signed that relates to the affairs of the LLC and conduct of its business; or
- If a manager operates your LLC, then ANY agreement between you two relating to the affairs of the LLC and conduct of its business could be construed as an OA.
What An Operating Agreement Should AddressBecause the Act is bare bones, the OA should address a wide range of issues, including issues that may arise among the members and matters between the members and the LLC. Bear in mind that generic OA’s downloaded from internet sources are unlikely to address these issues – almost always they simply re-state the provisions in the Act. A generic OA is no substitute for having a lawyer help you make tough decisions on questions such as:
- Do members have a right to resign? If so, what does that look like? Can that be structured so that remaining members aren’t unreasonably damaged?
- How will profits and losses be allocated?
- How will distributions be divided among the members?
- Will the LLC opt for taxation as a partnership? Will it make distributions to members to cover their tax liability from LLC income? If the IRS comes calling, will one member be designated as the spokesperson for the LLC?
- If members can assign their interest to a non-member, then does that non-member become a member after the assignment? How does that work?
- Will the LLC be managed by its members or by a manager? If the LLC will be “manager-managed” then who is that manager? What powers does she have? How can she be removed as manager?
- The Act ensures that members and managers are liable to the LLC under certain circumstances. An OA can reduce manager or member liability to the LLC beyond the Act’s default rule. Should a manager or members have a duty of loyalty or other fiduciary duties beyond what the Act imposes?
- Are members required to make additional contributions in the future? If the LLC runs short on capital, are members obligated to provide more funding? If so, how will that work?