Operating Agreements help an owner of a single-member limited liability company (SMLLC), in many ways.
Two reasons for creating an SMLLC are tax breaks and limited liability.
In the same way a business owner must prove income tax deductions by keeping accurate records, holding onto receipts, and following rules and procedures. Having an operating agreement, helps demonstrate to the court the owner of an SMLLC plays by the rules. And therefore, shielded from liability.
Not only does an operating agreement assist in protecting you from liability; it has other benefits as well.
Here’s some of them:
1. Operating Agreements Help Separate the Business from the Owner
A plaintiff will often try to go after the personal property of the business owner(s), which is known as piercing the corporate veil. A tactic used in piercing the veil, is declaring the business nothing more than an alter-ego of the owner(s). In other words, the business and the owner, are one and the same. This is called the Alter-Ego Doctrine.
By creating and following an operating agreement an SMLLC owner is taking positive steps towards separating him or herself from the company. A properly written operating agreement will set up rules and procedures, that follows tax guidelines and best business practices. Abiding by these guidelines and practices will demonstrate that the owner and the business are separate entities or “beings”. Therefore, a claim based upon the Alter-Ego Doctrine, will be less likely of succeeding.
2. Is a User’s Manual For the Owner
Operating agreements for single-member LLCs can function as a “user manual” for the owner. A well organized, thorough, and plainly written document will give a single member owner a clear idea of the legal nature of the business. An operating agreement establishes procedures and guidelines for how the business will operate, under normal conditions as well as when the unforeseen circumstances. An operating agreement will tell the owner how to administer their business.
3. Defines the relationship between a non-member manager and the single member owner
One of the many benefits of a SMLLC is the ability for an investor, or individual to have a passive role in the day to day business of the company. The operating agreement will define how much power the manager has. For instance, an independent producer might need an investor funds to make movie. The producer doesn’t want the investor around the set making decisions. A well drafted operating agreement excludes the investor from many decisions.
4. Avoids Colorado LLC “Default Rules”
Without an operating agreement, by default Colorado’s LLC statute, is your operating agreement. The statute was adopted from the Uniform Partnership Act. Since partnerships involve more than one person, the statute is more appropriate for multi-member LLCs. Many of the provisions in the statute doesn’t apply or makes no sense for single member LLCs. Moreover, sections of the Colorado LLC statute have been repealed, which gives little or no guidance to SMLLC owners. By passively using the default rules, it is easier for someone to pierce the corporate veil.
5. Allows for Succession and Incapacity Planning
A member of an LLC has a property interest in the company. When a member dies, the LLC interest has to be given to an heir. Without directions, the executor of the estate might not know who is entitled to the LLC interest. Likewise, if an owner becomes incapacitated an operating agreement can designate someone to manage the business.
6. Operating Agreements Protect the Interests of Creditors
An operating agreement for a SMLLC can be an agreement that involves third parties, such as banks.
Lenders are more likely to give you a loan if terms in the operating agreement protect their interests. A control agreement which is a three way understanding between the creditor, the member, and the LLC, will define the rights and obligations of the parties should the debtor default on the loan. Often, the lender becomes a member upon the debtor’s default. Without this provision, you may not get a loan, or if you do get a loan it may not have the best terms.
Likewise, terms to the agreement make it more difficult for a single-member LLC to file bankruptcy voluntarily.
7. Operating Agreements Will Help Your LLC Establish Credit
All businesses need a lines of credit. An operating agreement gives documentation to banks and other lenders about who may contract on behalf of the LLC. Having a company line of credit that is separate and apart from the owner is a way to earn liability protection.
To sum up, having a written operating agreement is necessary document that helps protect a business owner from liability. It will also help your business grow.
This article is for educational purposes only, and does not constitute legal advice about your case or situation. There may be exceptions to the information outlined above. Please consult an attorney if you have specific questions about your LLC.