Does My LLC Need an Operating Agreement?

A limited liability company operation agreement with pen

For people creating a business entity, especially for a single-owner business, establishing a limited liability company (LLC) can be a great option. First and foremost, as the name suggests, an LLC can protect the business owners from personal liability for the business’s debts. What’s more, an LLC is a “pass-through” entity for purposes of taxation; the business’s income avoids the double taxation of a C corporation and is simply reported on the owner’s personal income tax return. In addition, LLCs are flexible and typically involve less paperwork and administrative issues than other business entities. One important document an LLC should have, however, is an operating agreement.

What is an LLC Operating Agreement?

An operating agreement is a document that describes the ownership of the business and the duties of members and managers, as well as setting forth the details of their financial relationship. An operating agreement is similar to a partnership agreement. It is, in essence, a roadmap for how the business will be organized and run.

Are New Mexico LLCs Required to Have Operating Agreements?

Limited liability companies in only a handful of states (New York, California, Delaware, Maine, Missouri, and Nebraska) are required by law to have an operating agreement. While New Mexico doesn’t require LLCs to have operating agreements, that doesn’t mean you don’t need one. An operating agreement offers a number of important advantages, whether you are a single-member LLC or a multiple-member LLC.

If you have partners in your business, the LLC operating agreement can prevent squabbles over roles, rights, and responsibilities. There’s no need to jockey for position or status: the operating agreement defines what everyone does and is entitled to. A solid operating agreement can prevent unnecessary conflict, litigation, and dissolution of the company.

What if you are on your own? While there is no conflict over management of the business in that case, it is still important for single-member LLCs to have operating agreements.

Importance of Operating Agreements for Single-Member LLCs

Single-member LLCs are one of the most popular small business types in the United States. Given the advantages of an LLC described above, it is easy to see why an entrepreneur might want to create an LLC rather than operating as a sole proprietor who is personally liable for business debts. To create your LLC, you need only to file Articles of Organization with the state to officially register your LLC. But for the following reasons, you really need an operating agreement.

To Put the “Limited Liability” in Your LLC

An operating agreement is what allows your limited liability company to actually limit your liability. The LLC protects your personal property — your home, your personal bank account, your vehicles, etcetera — from lawsuits in case someone sues your business for some reason. Even if you are the only person running the business, you and the business are, legally, two separate entities.

But in order for this to work, you need to behave as if you and the business are separate. You can’t throw business funds in your personal bank account or vice versa (that’s called commingling funds) or ignore required formalities, like having an annual meeting, keeping minutes and maintaining certain records. In short, you can’t have both the benefit of treating business assets like they’re your personal assets, but have your personal assets held out of reach for business liabilities.

Without an operating agreement, it’s much less clear that you and the business really are separate. If your business gets sued, a court could decide that you’re not, and let a judgment creditor reach your personal assets.

To Convince Financial Institutions to Take You Seriously

You know that you own your business. But how does a bank or investor know that you own it? And if they don’t recognize you as the owner, why would they lend you money or invest in the business? The answer is the operating agreement. Your Articles of Organization may not be enough to identify you as the owner of the business. If you have an operating agreement, however, it will clearly establish that you are the owner of the company.

An operating agreement helps to legitimize your company, and you as its owner, to the people with whom you do business.

To Prevent State Law From Making the Rules for Your Business

States that don’t require LLCs to have operating agreements have rules that apply to those LLCs by default unless there is an operating agreement that specifies other rules. Obviously, you can’t make a rule for your LLC that violates New Mexico law. But there are some laws that will only apply to your LLC if you don’t specify otherwise in the operating agreement.

For instance, in New Mexico, if you become legally incapacitated as determined by a judge, your legal representative or guardian has the same rights in your business interest in the LLC as if you had assigned those rights to him or her. But what if you wanted those rights to go to someone else? You should have made that clear in an operating agreement.

Creating a New Mexico LLC Operating Agreement

If you want to have an LLC, you really should have an operating agreement. While an operating agreement can be a fairly straightforward document, it is best to have an attorney’s help to prepare it. Otherwise, you could leave out something important or find yourself bound by boilerplate language that sounds appropriate but doesn’t achieve what you want. If you need help with setting up an LLC or other business planning, please contact The Law Offices of Dana M. Kyle to schedule a consultation.

Categories: Business Planning