One of the most important decisions an entrepreneur makes is choosing the legal entity for their business. There are many options. The best formation type depends on the business and the number of people involved in its operation.
Many business owners choose a limited liability company (LLC) for their legal entity. This type of business can involve one or more people. The no. 1 reason people choose this entity is the personal liability protection it offers.
An LLC legal formation for your business helps safeguard your personal assets, but it is not foolproof. An operating agreement amplifies that protection. The document outlines how the company is managed, establishes ownership percentages, and governs other internal operations.
LLC vs. Sole Proprietorship
When one person is owned and operated by one person, a sole proprietorship might be an appropriate entity. A sole proprietorship is a simple structure. There is no annual filing. All profits and losses are passed through the owner’s personal income tax return. But that simplicity does come with a cost.
A sole proprietorship offers no layer of protection between the business and the individual’s finances. There is no liability protection against commercial debts, lawsuits, and obligations of the business.
An LLC does require more paperwork, enhanced record-keeping, additional taxes, and its own tax return forms; however, a significant advantage is its ability to shield the owner(s) from lawsuits, debt, and other business-related issues.
Purpose of an Operating Agreement
Some states require written operating agreements for LLCs registered in that state. The North Carolina Limited Liability Company Act allows the operating agreement to be in any form, including oral or implied. The document does not have to be filed with the state. This internal document provides the framework for the business.
An operating agreement establishes how the business will be run:
- Each owner’s percentage of ownership
- Each owner’s share of profits or losses
- Each owner’s rights and responsibilities
With a comprehensive operating agreement, everyone involved in the company fully understands the business operations.
The Added Value of an Operating Agreement
Even though a written agreement is not required by North Carolina law, it is recommended. Verbal agreements are more easily misconstrued or misremembered, increasing the chance of friction among the members. For LLCs with multiple owners, the operating agreement can minimize misunderstandings between the members and be the roadmap to settling disputes.
A written operating agreement also benefits single-owner LLCs. Without the document, a court could determine the owner operates more like a sole proprietorship and that the owner is subject to personal liability for a loss or incident involving the company.
Banks may also ask to see the operating agreement if you seek a business loan. A verbal or implied agreement will not meet their standards.
Create Comprehensive Operating Agreements for Your LLC
Forming your business as an LLC with an operating agreement minimizes the chance that you would be held personally responsible for any debt or liability incurred by the company.
While that protection is important, a comprehensive agreement should also include the following:
- How the dissolution of the business is handled
- How owners can be removed from the business
- How new owners can be added
- Under what circumstances could the business be sold
- What the succession rules are if an owner dies
- How disputes among owners will be resolved
- Non-compete clauses for owners
There are many considerations to weigh when creating an LLC and its operating agreement. Protect yourself and your business by using an experienced attorney from Jetton & Meredith, PLLC to guide the process.
Whether you are just beginning or have owned your business for decades, we can also advise you on lease agreements, contractor agreements, vendor contracts, franchise agreements, nondisclosure agreements, and more.
Schedule a consultation with our team to discuss the needs of your business. Send us an online message or call (704) 931-5535.