An Operating Agreement is a legally enforceable contract that governs relations between the members of the LLC and defines the business operations and governance structure of a Limited Liability Company. This internal agreement describes the members’ rights, voting power, obligations, and ownership interests in the company. The Operating Agreement could be compared to a constitution for the LLC or perhaps a blueprint for how your business is going to operate and make critical decisions.
Although it is not required under the Colorado LLC Act, no serious business owner would operate an LLC without an Operating Agreement in place. A formal written operating agreement lends credibility to your LLC’s separate existence. It also strengthens the “corporate veil” of liability protection that an LLC provides, which separates the owner’s personal assets from the debts and judgments against the LLC. Considering that personal liability protection is the main reason most business owners choose to form an LLC, any prudent business owner would want to help ensure that liability protection is available to them in the event their LLC is ever sued by a customer or vendor. In business related lawsuits, an Operating Agreement is used to help prove that the LLC is a separate legal entity from its individual owner(s). Therefore, when building a record for litigation, the Operating Agreement can be a key factor in protecting personal assets from judgment creditors of the business. Furthermore, LLCs without an Operating Agreement will be governed by default operating rules in the Colorado Limited Liability Company Act. Creating an Operating Agreement allows the business owner(s) to make their own decisions regarding the operation of the LLC instead of relying on ridged state statutes which will apply automatically in the absence of an Operating Agreement.
Unfortunately, many small business owners believe that simply filing an LLC with the Secretary of State provides them with all of the liability protection they need. However, the prudent small business owner must takes steps to build the corporate veil of liability protection brick by brick. Whether the LLC has multiple members or a single member, having a professional prepared Operating Agreement is a vital component to keeping the liability protection intact for your LLC.
The LLC Articles of Organization must been filed with Colorado Secretary of State. There is a common misconception that the Operating Agreement must be filed with a governmental entity as well. However, the LLC Operating Agreement, which is an internal business agreement, does not need to be filed with any state or local government agency.
Best practices dictate that the members should make all LLC decisions according to the specifications (necessary voting percentages) in the LLC Operating Agreement. Additionally, key decisions should be documented in writing (by a signed and dated company resolution) and such documentation should be kept with other important company documents.
Summary of Advantages of Having a Written LLC Operating Agreement
1. Helps to ensure that courts will respect the corporate veil of liability protection between your personal and business assets if your LLC is ever sued.
2. Helps to legally establish that your LLC is a legitimate business apart from you as an individual, because you operate the LLC according to the terms of the Operating Agreement.
3. Sets forth the rules that will govern the financial affairs and voting procedures for your business.
4. Gives the LLC members a clear understanding of their financial and management obligations regarding their involvement with LLC.
5. Allows the LLC owner(s) to establish operating rules to their liking, which supersede the rigid default rules found in the Colorado Limited Liability Company Act.