Two Huge Reasons Your LLC Needs an Operating Agreement

So, you’ve just decided to start your business. You’ve looked online and you know that you want to form a company and take advantage of limited liability for your company. You’ve decided that a limited liability company is the company form you want to do. Now what? Is it really just as simple as filing a piece of paper with the Idaho Secretary of State’s office? Is that all that is required to get your precious idea working? What else do you need? Do you need an operating agreement? These are questions that business lawyers hear every day. So, today, I’m going to address whether or not you need an operating agreement.

What Is An Operating Agreement?

First off, just in case you’re not sure what an “operating agreement” is, an operating agreement is a document that governs the relationships among the company owners. It’s like a partnership agreement for a partnership, or bylaws for a corporation. It’s a contract. Believe it or not, even if you don’t sign a formal operating agreement, you and your owners have one… Idaho Code provides default provisions that govern the owners’ conduct. These provisions are located starting at Idaho Code §30-25-101. Those code sections outline all of the obligations, duties, and rules by which the owners of an LLC must abide. By the way, the owners of an LLC are called “members” much in the same way that owners of a partnership are called “partners” and owners of a corporation are called “shareholders.”

Reason One: Prevent Accidental Agreements

Getting back to the point at hand, however, it is highly important to understand that the default state law provisions governing your LLC can be changed. Well, 99% of the default provisions can be changed; there are a couple of provisions that are not allowed to be altered. To see what can and cannot be altered by an operating agreement, look at Idaho Code §30-25-105. What’s even more important to note is that those provisions can be changed orally or in writing (yes, you can have an oral contract… it does not need to be in writing). So, even though you may not have a formal, written operating agreement, you can enter into oral contracts (i.e. an oral operating agreement) inadvertently. That leads us to the number one most compelling reason to ensure that you have a written operating agreement: to ensure that you don’t accidentally or inadvertently agree to an oral agreement with the other members of the LLC.

You see, the issue with allowing oral agreements to govern the LLC is that everyone seems to remember things a little bit differently. When (not if) something goes wrong, without a written provision governing the conduct and actions of the members, each person is left to their own recollection about what the other members have said and done. A “he-said-she-said” dispute may arise, which is always ugly to deal with because then you’re left trying to prove what someone else said or did… and they are usually claiming that you said or did something just opposite.

So, to avoid the “he-said-she-said” disaster, it is highly recommended that you enter into a well written operating agreement that sets forth the understandings of the members and provides that the operating agreement cannot be amended except in writing. Such an operating agreement provides simply that the written operating agreement contains the full understanding and agreement of the members and cannot be altered unless signed in writing by all (or the majority) of the members. Preventing the oral alteration of an operating agreement is vitally important and very valuable to ensure that your duties, obligations, rights, benefits will not whimsically change with the opposing interpretations of a member's conduct or words.

Reason Two: Knowing Your Responsibilities

Now, I understand that I promised I would tell you whether or not you need an operating agreement. However, by providing a clear understanding of what benefits can be derived from an operating agreement, the answer to the question, “who needs an operating agreement” will be clear. So, without further ado, the second most compelling reason to have an operating agreement: to ensure that everyone knows their obligations and responsibilities. Simply put, when you prepare a formal, written operating agreement it is set in stone (or at least ink) what everyone can and cannot do. In my experience, it seems like members of an LLC rarely refer to the operating agreement unless there is a problem. When the business is working well and profits are flowing the way they should people generally get along. But what about when those profits stop? Or the going gets tough? That’s when disputes tend to arise.

Any well-versed business lawyer will try to peer into his or her crystal ball to foresee what kind of issues may arise in the future… and then deal with those issues then and there while everyone is still getting along (it’s so much easier to deal with issues in advance, as opposed to when we’re in the throes of the problem). In fact, when I draft operating agreements, my goal is to try and foresee every possible issue that may arise and then draft a solution for it in the operating agreement. As a result, most of the operating agreements that I draft range from 25 to 70 pages long. Now, I’ll be the first to admit that most (if not all) of my clients only ever use 3 to 7 pages of that operating agreement. The trouble is, I don’t know which 3 to 7 pages they’ll use! For one client, it’ll be the pages that set the voting requirements; for another, it’ll be the buy-out provisions; and for another, it’ll be the dissolution language. I simply don’t know what issues your company will face in the future, and so I draft my hardest to cover them all.

So Which LLCS Need One?

So, with that backdrop and understanding of what an operating agreement does and the benefits it conveys, we can finally answer the question of: “do I need an operating agreement for my LLC?” I generally break the answer into three categories: LLC’s with a single member, LLC’s with spouses as the only members, and LLC’s with multiple, non-spouse members.

As for LLCs with a single member: the short answer is, “no, you do not need one.” If you’re the sole member of an LLC, there cannot be a “he-said-she-said” problem (unless, of course, you have multiple personality disorder). You’ll never get into a fight with yourself. You’ll never disagree with yourself over whether or not you have the authority to perform a particular action on behalf of the company. There simply is no room for dispute or misunderstanding… because it’s just you. So, don’t sweat it. You don’t need an operating agreement.

As for LLC’s with spouses. Remember, the two primary benefits are making sure that won’t end up in an oral agreement situation and ensuring that everyone understands their duties and obligations. Well, with spouses, I’ve seen that most tend to get along better than regular members of an LLC. Maybe it’s the pillow talk? Either way, spouses tend to be on the same page when it comes to who does what and how. As such, there are fewer problems that I encounter when spouses are the sole members of LLC’s. That’s not to say there can’t be problems… just that the risk is must lower. So, the vast majority of the LLC’s where the only members are married, my recommendation is that an operating agreement is not necessary.

As for the last category, which encompasses any other scenario, including father-and-son (and other like situations) businesses, I always recommend that you prepare an operating agreement. The chances and risks of a disagreement are too vast. Nothing ever seems to go perfect. Sooner or later a problem will arise. When it does, if everyone knows what their obligations and responsibilities are in advance, experience shows that people follow through with their duties.

So, in conclusion, whether or not you need an operating agreement depends on whether or not you have other members in the company and the type of relationship you share.