Your partners are all in agreement, you’ve filed your paperwork with the state, you’ve paid your fee, and you’re up and running. You’ve probably fulfilled all the technical requirements of founding an LLC, but you should still draft and sign an operating agreement (even if it’s just you). Here’s why:
Why does anyone create an LLC, or a corporation for that matter? Sometimes it’s to make it easy to pool resources, to provide for perpetual existence, or just to organize ownership and control. But one of the biggest reasons is right there in the name, to reduce or eliminate personal liability for anything that happens as part of the business. That is, you want to make sure that if you screw up as part of the business and cause damage to someone, that that person can’t go after your personal stuff to make up those damages, only the business assets (and insurance). Failing to have an operating agreement in place can undermine this entire purpose of having an LLC.
As a default rule, when a company is organized as a corporation or an LLC and it gets sued, the individual owners are protected from personal liability. That is, the person suing the company can only collect their judgment out of the assets of the company, but not the assets of the individual owners.
When a company lacks the resources to pay a judgment, a court will sometimes look beyond the company itself to the owners and impose personal liability. This is called “piercing the corporate veil,” because that’s totally a normal phrase and not weird at all. In most jurisdictions a court will only do this when failing to do so would work some kind of fraud upon the injured party, and when that fraud is paired with one of several other corporate sins. One of the most common, and easiest to fall into, sins, is failing to properly observe the corporate form and treating the corporation or LLC as simply an extension of yourself.
So what does an operating agreement have to do with all of this? Well, an operating agreement sets out the very basic structure of the LLC and how it will be governed. Especially for a single-member LLC, an operating agreement will typically impose very few duties on an owner, but what it does is it shows that you’ve undertaken at least the minimum amount of organization. By abiding by the minimal requirements set forth in the operating agreement, you then end up with a track record for your company where you’ve established and paid attention to the corporate form, and shown that you treat the company as something separate from yourself. That way, if and when you ever get sued, you’ve now got a corporate history designed to counteract any argument that you should personally be held liable, and that’s really what having an LLC is all about anyways.
More simply and more immediately, in many jurisdictions, Massachusetts included, it’s really important to have an operating agreement because your initial state filings don’t require that any members, and their respective membership interests, be specified. So on the most basic level, if you don’t have an operating agreement, you don’t have any document that says you actually own anything.
Of course, there are plenty of other reasons that your LLC should have an operating agreement, and a whole host of clauses that you can include in it, so stay tuned for that in future posts.