Reasons for Having an Operating Agreement

November 30, 2015

Although many states, including Wisconsin, do not require that a limited liability company have an operating agreement, there are multiple reasons why a company should, nevertheless, consider adopting one. This article discusses several compelling reasons why companies should adopt an operating agreement.

First, while members of limited liability companies may deem it unnecessary to have a formal operating agreement (especially in the case of a sole member company), without the formality of an operating agreement, the company may be viewed as a sole proprietorship which could potentially jeopardize its limited liability status. Obtaining personal liability protection against claims is often a primary reason why people choose to form a limited liability company in the first place, and avoiding circumstances which could jeopardize this protection should be paramount.

Second, having an operating agreement allows members to take advantage of one of the primary benefits of limited liability companies – the ability to highly customize the relationship among members. For instance, multiple-member companies can use their operating agreements to define the financial and managerial structure of the company. From a financial perspective, members can determine how best to allocate the company’s profits and losses by using an operating agreement. In Wisconsin, if the members have not specified how profits and losses are to be allocated, then profits and losses will be allocated on the basis of the value of the contributions made by each member. This may or may not be acceptable depending on the circumstances. From a management perspective, having an operating agreement allows the members to specify the role that each member will play within the company. For instance, there are circumstances where the members will want a single member (or perhaps a nonmember) to manage the company, while the remaining members will be silent investors and shall only be consulted on certain significant managerial decisions as outlined in the operating agreement. In Wisconsin, in the absence of an operating agreement, the affirmative consent of the majority of the members is required to determine any matter connected with the company.

Third, an operating agreement can allow members to expressly determine the circumstances upon which shares may be voluntarily transferred, or how transferability will be dealt with in the event of an involuntary transfer, death, disability, divorce or retirement. Dealing with transferability issues from the outset is extremely important so that a member does not end in an unworkable business relationship.  This situation can easily occur, for instance, where there is an established working relationship between members, but the shares are transferred to a spouse or children. Finally, apart from the preceding consideration, there are many additional circumstances where an operating agreement will help you avoid state default rules that may not be the best fit for your circumstances. At Axley Brynelson, LLP we help clients not only choose the correct entity for their business, but also implement an agreement to adequately address the circumstances on the front end.

For more information about "Reasons for Having an Operating Agreement," contact Clarke Sugar at csugar@axley.com or 608.260.2481.