Congratulations! You have formed your own business, choosing the limited liability company as its corporate structure. With hard work, skill, and dedication, your new business is sure to go places. Now you are hearing about something called an “operating agreement”; in fact, your lender is requiring it. You think, “I thought an LLC did not need documents like a corporation. What is an operating agreement, and do I need one?”
An operating agreement is a document that governs how a limited liability company makes decisions, from day-to-day management to major investments such as purchases and sales of property. Illinois law does not require that the company have an operating agreement. In that case, the rules for management of the LLC are provided in the Illinois Limited Liability Company Act.
However, it is often important to have an operating agreement for the following reasons:
- The members want the company to be governed by different rules than what the Act provides
- It provides a “blueprint” or “constitution” for how the LLC is to be operated
- Specifically, an operating agreement provides for the rights, powers, and duties of the members (that is, the “owners”), and the managers (the people the LLC appoints to operate the business, who could be but do not have to be members)
- Lenders will usually want its LLC borrowers to have one
- It helps preserve the distinction between the LLC’s assets and those of its members as individuals
Often it is not necessary for a single-member LLC to have an operating agreement. However, it can be helpful for even those companies to have one as a reference point for how the business is to be run, especially if the owner prefers to have rules different from what is provided in the Act, or the LLC’s lender is requiring one.
If an LLC has more than one member, we believe it is essential to have an operating agreement, for many reasons. First, the “rights, powers, and duties” aspects, including payment of managers for their services operating the business, become even more important when there is more than one member, as the inevitable question of who gets to do what will arise. Coming to an operating agreement that sorts out these issues when the business is founded can prevent disputes from arising later. Second, an operating agreement can be used to comply with other rules and regulations. An obvious example is allocating gains and losses correctly according to tax law, but there are others. For instance, an LLC with a woman as the majority owner and a man as minority owner will want an operating agreement specifying that the woman is to have full control over the operation of the business if it wants to qualify as a “woman-owned” business. Third, there needs to be some procedure in place in case a member dies or wants to leave the company, or the company wants to expel the member.
We do not recommend using “cookie cutter” agreements, because they might not address your company’s specific needs, and there is no one to explain what the terms really mean for your company. An attorney experienced in the issues facing entities such as LLCs can help you create an operating agreement that addresses the needs and desires of the LLC and its members, and help you understand what it is you are agreeing to. With an agreement in place, your company can be secure that it has an operating framework and can concentrate on doing the business you love!