Why You Should Have an Operating Agreement for Your LLC

Limited Liability Companies (LLCs) are popular business entities which are beneficial if the business owners want protection from personal liability, pass-through tax treatment, and flexibility in management. LLCs can be created quickly, are highly customizable, and can be changed as the company grows. By default, an LLC operates under the statutes found in Title 23 Article 18 of the Indiana Code. An operating agreement allows the LLC to avoid the State’s default rules, with a few exceptions. Further, an operating agreement is helpful in protecting owners from personal liability, defining the rights between the owners of the LLC, and customizing your business structure.

An LLC’s limited liability protection is only useful to the owners of the LLC if the owners actually treat the LLC as a separate entity from the owners. When owners do not act like the LLC is a separate legal entity from themselves, either through commingling of LLC funds with individual owner’s funds, committing fraud, or ignoring corporate formalities, plaintiffs can pierce the corporate veil and make the owners personally liable for the actions of the company. An operating agreement helps to prevent that piercing by setting out how the company will operate. If the company operates in accordance with the operating agreement, plaintiffs have a much more difficult time piercing the corporate veil, thus protecting the personal assets of the owners.

When an LLC has two or more owners, things can become complicated. Voting rights, management rights, and the rights for each owner to bind the company in contract must all be decided. This area of an operating agreement is highly customizable because the agreement can force the owners to unanimously agree on decisions, only require a simple majority of ownership (>50%) for decisions, or require an amount of ownership consensus anywhere in between the simple majority or unanimity. Each type of vote can also require its own specified level of agreement. Further, these decisional thresholds can be based on different factors. For example, the option to vote could be based on percentage of membership interest in the LLC or each owner could have an equal vote regardless of how much of the company they own. Even with a single-member LLC, defining these rights, especially the rights to assets, help protect the owner. Other factors to consider when defining the relationships of owners include:

1. How ownership interests may be transferred;
2. How profits and losses are distributed;
3. What happens when an owner passes away;
4. What happens when the company needs more capital;
5. How owners can be added or removed; and
6. Whether owners will receive distributions?

One of the great benefits of an LLC is customizing the business structure. The LLC statutes allow for an LLC to be classified as a partnership or a corporation for tax purposes, which can be used to an owners advantage depending on what the owners long-term goals are. You can define the purpose of the business as any legal purpose you desire and change the business of the LLC as opportunities arise.

LLCs are great, but an operating agreement should be a top priority when you want to limit your personal liability. McNeelyLaw LLC drafts these operating agreements often and are happy to create a custom agreement that fits your company. Call us at 317-825-5110 to talk to an experienced business attorney to protect your interests.

This McNeelyLaw LLP publication should not be construed as legal advice or legal opinion of any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own lawyer on any specific legal questions you may have concerning your situation.