A single-member limited liability company (SMLLC) business is a one-owner business. The SMLLC is taxed like a sole proprietorship, but being an LLC has advantages in limiting your liability and acting like a "real" business.
One of the ways to act like a real business is to have the same type of documentation that other LLC owners have. An LLC with more than one member (the owner) has a document called an operating agreement that is prepared with the help of an attorney when the business begins.
This article looks at how an operating agreement works for a single-member LLC, and what to include in this document.
What Is an Operating Agreement?
All LLC's should have an operating agreement, a document that describes the operations of the LLC and sets forth the agreements between the members (owners) of the business.
LLCs are formed under state laws, so the requirement to have an operating agreement is different for each state. Some states require an agreement for all LLCs, while others allow oral agreements. You don't have to file your LLC's operating agreement with your state.
Even if your state doesn't require a written operating agreement, it's still advisable to have one. An operating agreement that is not in writing won't help you if you are audited by the state or are involved in a lawsuit.
How an Operating Agreement Works
If there is only one owner of an LLC, is an operating agreement still necessary? The answer is, yes. Here are several reasons a single-member LLC needs to prepare an operating agreement—and abide by it.
Protecting the Limited Liability Status of Owners
The most important reason to form a solo business owner to form an LLC rather than operating as a sole proprietor is to protect the owner from personal liability from business activities. Limited liability means that the owner's liability from debts and lawsuits is limited if they act within the guidelines of the operating agreement.
An owner isn't protected from personal liability if they do something outside the guidelines of the operating agreement, like committing a crime or having a conflict of interest.
Setting the Policies for Operating the LLC
As noted above, an operating agreement describes the operations of the LLC, setting out the overall policies for running the business. The agreement also clarifies how LLC funds are contributed and distributed to the owner. These policies guide the owner in making decisions.
Separate the Business from the Owner
Having an operating agreement and keeping records of operations helps establish the separation of the business from the owner for liability and tax purposes. If you don't have an operating agreement, you will find it more difficult to show that you and your business are separate entities.
Clarify Business Succession
An operating agreement also clarifies what happens if the owner dies or is unable to run the business—that is, it creates a succession plan. Your operating agreement should include a clause stipulating who will manage the LLC if you are unable to do so. Without this specific provision, it may be difficult for your family to continue the business or dispose of it without a lengthy legal battle.
Avoid State LLC Default Rules
If an LLC has no operating agreement, it is subject to the "default rules" of the state in which the LLC is organized. Letting the state tell you how to dispose of your business assets is not what you want for your LLC, so your operating agreement needs to be specific to your situation.
What To Include in an Operating Agreement for a Single-Member LLC
A general LLC operating agreement, even if it has just one member, should include the following.
Purpose and Jurisdiction
All businesses must act within the limits of their stated purpose. The purpose statement in your operating agreement (sometimes called a mission statement) should be specific as to industry and business type but broad enough to include changes in products or services you sell. The agreement must also define the jurisdiction (type of court) where cases involving your business will be tried.
Ownership and Shares
The agreement must describe:
- How and when an owner must contribute capital (cash, securities, or other assets) to the organization
- How their capital account and ownership percentage is determined
- How profits and losses are determined and distributed
- What happens to an owner's account if they leave, die, or are divorced
Management of the LLC
LLCs can be managed by the members or a manager, and this should be spelled out in the agreement. In a single-member LLC, the owner usually manages everything, but you may want to consider hiring a professional manager to give you more time to work on the business.
Meetings and Voting
The LLC owners should meet regularly (similar to a board of directors) and the agreement should describe when meetings are to be held and how decisions will be made (majority vote, two-third vote, or other). Even if it's just you as the only owner, you should record all policy decisions. For example, keep a record of your decisions to select a bank, legal counsel, and an accountant or CPA.
Transfer of Ownership
This section is most important for a single-member LLC since there's no other owner to take charge in case the single owner can't manage the business any longer. Procedures for managing the business in this event should be described in great detail.
An operating agreement isn't a one-time "cast in stone" document. It needs to be updated periodically to adjust for changes.
Get Help From an Attorney
You can use "free" legal forms online to create an operating agreement, but you are better served by getting the help of an attorney. Your attorney can make sure all the relevant clauses are included, and make sure your specific requirements are followed.
Frequently Asked Questions (FAQs)
How do you change the operating agreement for an LLC?
An LLC can change its operating agreement at any time. The operating agreement itself should include a process for making changes.
A single-member LLC owner can work with their attorney to make the changes, making sure that the date of the changes is documented. It's essential to have an attorney help with the wording of the changes to make sure they say what you want them to say and that they are in line with state laws. You might use a meeting minutes template for this purpose.
Is an LLC required to have an operating agreement?
The requirement for an operating agreement differs for each state. Some states require this agreement. New York requires all LLCs to have an operating agreement within 90 days after filing the articles of organization. California requires all LLCs to have an operating agreement, but it doesn't have to be in writing.
Check with your state's business registration division (usually under the secretary of state's office) for requirements for forming an LLC.
Should an operating agreement detail who owns the LLC's intellectual property?
Most small businesses have some type of intellectual property (IP), including patents, trademarks, and trade secrets, that they use to generate income directly or by licensing. This property may have been created by individual employees or independent contractors (non-employees), and the ownership of the property should be included in the employment agreements with these individuals.
Because IP is an asset of the company, the operating agreement may include language that specifies that the company owns, and has the right to license, intellectual property.