What is an operating agreement?

An operating agreement is the blueprint for how your business operates. It describes what happens when disputes arise between members, how membership interests can be transferred, and who runs the business. For instance, it usually talks about whether an LLC is member-managed or manager-managed. It will also talk about the membership interest, who owns them, what compensation was paid for those interests, and how those interests are given up. In some cases, it may talk about what percentage of membership interest votes allows certain measures to pass. It may also state what happens if a member goes bankrupt, gets divorced, or dies.

Why do I need one?

If the LLC has more than two members, an operating agreement talks about what happens between the members. It talks about voting percentages, how much was paid for the membership interests, and how membership interests can be transferred. I like to think of it as the operating manual for a business – without, a business can still operate but has no idea what to do during a crisis.

So does a single member LLC need one? The single member LLC doesn’t need to worry about disputes between members. The single member LLC doesn’t need to worry about how a transfer occurs because the single member has full control of transfers. However, even with this in mind, a single member LLC does need an operating agreement!

An individual starts an LLC or corporation for two reasons: 1. to gain a tax break and 2. to gain limited liability. The tax break occurs because, depending on the tax structure chosen, an individual may be able to plan better for retirement, take more business deductions, or lessen the employment tax liability. The limited liability occurs when the LLC is treated like a separate entity. However, this limited liability is not handed out easily. An LLC must earn this limited liability. This means that an LLC must be treated as a separate entity from the business owner. When an LLC has multiple owners, it may be easier to show that the entity is separate from its owners. The business owners can probably show that they established a separate banking account and that control is vested in several people (i.e. the multiple owners). However, when the person is a single member LLC, it can be difficult to show the business was really operated in as a separate entity. For instance, even though the business has a separate business account, the person that controls that business account is the sole owner. Due to the nature of a single member LLC, it will be difficult to show that control is vested in multiple people.

This is why it is important to have all the paperwork in order to show that the individual operated the LLC as a separate entity. For an LLC, an operating agreement is the first of many documents that will show the entity truly is separate. The operating agreement, in addition to the correct state, federal, and additional documents that are kept by the business owner are the building blocks for showing the entity is truly separate. By showing that the building blocks are followed, along with the other things that need to be done to show that in practice it is separate, individuals who own LLCs can help ensure that the LLC keeps its limited liability.

To find out if you have everything in order to show your LLC is a separate entity for limited liability purposes, call Elizabeth Lewis at 720-258-6647 or email her at elizabeth.lewis@eclewis.com today.

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