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LLC Operating Agreements: Don’t Opt Out

Texas law does not require limited liability companies (LLCs) to create and file operating agreements. However, that fact alone should not sway your decision whether to devise an operating agreement for your LLC. In fact, the legal right to continue without one should be disregarded in the calculus for determining how to proceed, because of the manifest benefits that operating agreements bring.

Operating agreements establish the structure of your entity, help guard the entity’s limited liability entitlements, and create governing rules for the business. The LLC structure is relatively flexible to accommodate needs regarding the roles and rights of each owner by dictating how the owners will split profits, divide work, distribute shares, and more. Conversely, S-Corps and C-Corps place far stricter limits on the company’s ability to self-select the roles and rights of each individual owner. As an example, an owner’s right to receive profits or losses from the business is generally tied directly to the owner’s capital investment in the company. So an owner who invested 45% of the capital would receive 45% of any profit or loss. But an LLC allows you to select different arrangements. Despite disparate work or investment ratios among its owners, an LLC can choose to split profits and losses 50/50 by stating so in an operating agreement.

Furthermore, LLCs without any formal operating agreement are treated with additional scrutiny by the courts, especially if there is any commingling of business and personal money or other activity that calls the legal separateness of the entity and its owners into question. But LLCs are afforded greater respect by the courts when they have created an operating agreement. The existence of an operating agreement is an easily provable fact that establishes intent to maintain separation between the company’s legal person and those of each individual owner. Without that, the limited liability of an LLC could be seriously jeopardized.

And finally, choosing not to create an LLC operating agreement subjects the LLC to the Texas default LLC rules, which are not specifically tailored to the needs and goals of your business. So take charge of the opportunity to shape the rules to fit the goals of your business. The operating agreement will allow you to do so while raising the guard on your company’s limited liability, and dictating the profit and loss allocation method that best suits the needs of each owner.

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