What could possibly go wrong if you and your fellow limited liability company owners decide to operate your LLC without an operating agreement?
Lots of things, many of which could cause you significant financial pain and mental distress.
Many business partners who form an LLC decide not to develop and adopt an operating agreement for their LLC because the state in which they are forming their LLC has an LLC Act that provides default provisions absent a written agreement. Thinking that their state’s LLC Act is comprehensive and fair, they may not see a need to adopt their own operating agreement to save on expenses early in the life of their LLC.
But such a decision could prove to be short-sighted, particularly if, and when, a dispute arises among the owners of the LLC.
By adopting a well-developed and custom-tailored operating agreement for their LLC, the owners can preemptively avoid many potentially-painful pitfalls, including:
- Arguments among the owners of the LLC relating to the rights and responsibilities of each owner. This pitfall can be avoided by detailing such rights and responsibilities in a clear and custom-tailored manner in their operating agreement.
- Suffering harm because state default laws are not optimal for their LLC. This pitfall is avoided when owners agree to different, custom-tailored rules in their operating agreement. For example, while a state’s LLC Act may require a unanimous vote among the owners of the LLC for a certain corporate action, the owners may prefer a simple majority or “supermajority” standard which they can include can in their own operating agreement. Similarly, while the applicable state’s LLC Act might provide for a certain method of distributing profits and losses, the owners of the LLC may determine that a different allocation is more appropriate.
- Disputes arising because the owners did not have a clear agreement in advance. The applicable state’s LLC Act does not adequately address disputes. For example, the applicable state’s LLC Act might not address the rights and responsibilities of each owner when the LLC needs more capital or whether an owner of the LLC is prohibited from separately creating a new business that competes with the LLC. By addressing these matters in their operating agreement, the owners of the LLC know each other’s expectations and may avoid disputes in the future.
Because each LLC is different and the relationships between owners of LLCs vary greatly, accepting one-size-fits-all state default laws for an LLC can be dangerous. A well-developed and custom-tailored operating agreement provides LLC owners with a valuable option.