Do I Need an Operating Agreement for My Business? A Guide for Clients.
When starting a business, many people are eager to jump into making money without getting bogged down by legal paperwork. One important document that often gets overlooked is the operating agreement. This vital document can play a significant role in the success and stability of your business. In this post, the experienced business lawyers at Thompson Legal explore the importance of an operating agreement.
Please note that this post is not exhaustive, and every situation is unique. In the event that you have questions about your business, it’s advisable to speak with a licensed attorney. Contact Thompson Legal to schedule a discovery call with a Michigan business attorney.
What Is an Operating Agreement?
An operating agreement is a legal document that outlines the internal workings, ownership structure, and management responsibilities of a limited liability company (LLC). Although not required by law in most jurisdictions, it is highly recommended especially for multi-member LLCs. The operating agreement serves as a set of rules and guidelines for how the business will operate and make key decisions.
Why Is an Operating Agreement Important?
Clarifies Ownership and Responsibilities: An operating agreement clearly defines each member's ownership stake in the LLC and outlines their roles and responsibilities. This can help prevent later disputes and conflicts. The operating agreement can also be used to prove your ownership interest to third parties - like financial institutions and investors.
Protects Limited Liability Status: Without an operating agreement, an LLC may be subject to default rules set by state law. Having an operating agreement in place can help maintain the limited liability protection that LLCs offer.
Decision-Making Structure: The document sets out how decisions are made within the company, whether it's through majority vote, consensus, or another method. This helps avoid disagreements and confusion.
Management Structure: An operating agreement can specify who will manage the day-to-day operations of the business and who will make major strategic decisions.
Dispute Resolution: An operating agreement outlines how each member is required to address potential legal disputes, and the required venue. Some entities prefer to require more private resolution methods - like arbitration, while others push for mediation.
Inheritance Planning: Operating agreements can also direct how interests should be addressed in the event of incapacity of death - avoiding the need for a probate.
Exit Strategies: Operating agreements outline what happens in the event a member wants to sell their stake, leave the business, or pass away, ensuring a smooth transition.
Do You Need an Operating Agreement?
Number of Members: In general, the more members a business has, the more crucial an operating agreement becomes. Single-member LLCs may not need one as urgently as multi-member LLCs, but it can still be beneficial.
Decision-Making: If you want a clear process and structure between members as your business grows, an operating agreement is essential.
Long-Term Goals: If you anticipate growth, changes in ownership, or the addition of new members, an operating agreement can provide the necessary framework.
Legal Requirements: Check your state's legal requirements. Some states may mandate an operating agreement for LLCs, while others don't have any specific regulations.
Consider the case of Altobelli v Hartmann, where members of an LLC had an operating agreement, but one member sought court intervention. The existing operating agreement called for the use of private alternative dispute resolution. Ultimately, the Supreme Court weighed in and dismissed the case to arbitration due to the members’ failure to use and follow the processes within their operating agreement for resolving the dispute among the members. The Altobelli case is a clear example of why it is of vital importance to fully read and understand the content of your operating agreement.
Conclusion
In the world of business law, an operating agreement is a powerful tool that can provide clarity, protection, and structure to your business. While not always legally required, it is a wise choice for most businesses, especially those with multiple members. Remember, an investment in legal paperwork today can save your clients from costly disputes and legal challenges in the future. If you are a Michigan business considering an operating agreement, contact Thompson Legal to schedule a discovery call with an experienced Michigan business attorney.
This post contains general information about business entities and operating agreements. To inquire about your specific circumstances or for assistance crafting an operating agreement that fits your needs, please Contact Us at Thompson Legal to speak with an attorney.
