Operating Agreements for your Small Business
- Nathan Harding
- Jul 26
- 6 min read
Why Small Businesses Still Need Operating Agreements: It's Not Just About You
You formed a single-member LLC and elected to be disregarded for tax purposes. Simple, right? You might be thinking, "Why do I need an operating agreement? I'm the only member - no one else will see it anyway."
This is one of the most common misconceptions I hear from new business owners. The truth is, even single-member LLCs need operating agreements, and plenty of people besides you will want to see it. Here's why this document is critical for your business, even when you're flying solo.
What Is an Operating Agreement?
An operating agreement is the foundational document that governs how your LLC operates. Think of it as your LLC's internal rulebook. It outlines ownership structure, management responsibilities, profit distributions, decision-making processes, and what happens if circumstances change.
For multi-member LLCs, it's obviously essential to prevent disputes and clarify everyone's roles. But for single-member LLCs? It's just as important, for entirely different reasons.
The "Nobody Will See It" Myth
Here's the reality: Your operating agreement isn't a private document that stays locked in your desk drawer. Throughout your business's life, various parties will request to review it. Let's look at who wants to see it and why.
Banks and Lenders
Every time you apply for business financing - whether it's a small business loan, line of credit, or equipment financing - lenders will request your operating agreement as part of their due diligence process.
Banks need to understand:
Who has authority to sign loan documents
How the business is managed
What happens to the debt if ownership changes
Whether there are restrictions on borrowing
Without an operating agreement, you'll either be denied financing or face significant delays while you scramble to create one. I've seen clients lose out on time-sensitive financing opportunities because they couldn't provide this basic document.
Insurance Companies
When purchasing business insurance policies, particularly liability coverage, insurance companies often require your operating agreement to:
Verify who has authority to purchase coverage
Understand the business structure for underwriting purposes
Determine coverage needs based on business operations
Establish who can make claims
Vendors and Suppliers
Large vendors and suppliers increasingly request operating agreements before extending credit terms or entering into significant contracts. They want to confirm:
Who has authority to enter contracts
The stability and structure of your business
Whether there are restrictions on business operations
Professional Service Providers
Accountants, attorneys, and other professional advisors need to review your operating agreement to:
Understand how your business operates
Provide appropriate tax advice
Ensure compliance with state law requirements
Draft other business documents correctly
Future Business Transactions
Your operating agreement becomes even more critical if you plan to grow or eventually exit your business.
Adding Partners or Investors
If you decide to bring in partners or investors, your existing operating agreement serves as the foundation for negotiations. It demonstrates that you've thought seriously about business structure and operations. Without one, potential partners may question your business sophistication and preparation.
The operating agreement also makes the transition smoother by establishing:
How new members are admitted
Valuation methods for ownership interests
Management structure changes
Profit and loss allocation methods
Business Sales and Acquisitions
When selling your business, buyers will demand to review your operating agreement as part of due diligence. They need to understand:
How the business has been managed
Any restrictions on transfer of ownership
Outstanding obligations or commitments
The legal structure they're acquiring
A well-drafted operating agreement can actually increase your business value by demonstrating professional management and clear operational procedures.
Merger Opportunities
If another business wants to merge with yours, their attorneys will scrutinize your operating agreement to identify any potential complications or restrictions that could affect the transaction.
Legal Protection Benefits
Beyond third-party requirements, an operating agreement provides crucial legal protections for single-member LLC owners.
Maintaining Limited Liability Protection
One of the main reasons business owners choose the LLC structure is limited liability protection - keeping personal assets separate from business liabilities. However, courts can "pierce the corporate veil" and hold you personally liable if you don't treat your LLC as a separate entity.
An operating agreement helps establish that you're operating a legitimate business entity, not just using the LLC as a personal alter ego. It demonstrates to courts that you've taken the LLC structure seriously.
Clarifying Business vs. Personal Activities
Your operating agreement should clearly define what constitutes business activities versus personal activities. This distinction becomes crucial if:
You face personal or business lawsuits
The IRS challenges business expense deductions
Insurance companies investigate claims
You need to prove business legitimacy
State Law Compliance
While many states don't require operating agreements, they all have default LLC statutes that govern your business if you don't have one. These default rules may not align with how you want to operate your business.
For example, default state law might require:
Specific voting procedures for business decisions
Particular methods for handling business records
Predetermined rules for adding members
Standard procedures for dissolving the LLC
An operating agreement lets you customize these rules to fit your specific needs and preferences.
What Should Your Operating Agreement Include?
A comprehensive single-member LLC operating agreement should address:
Basic Business Information:
LLC name and purpose
Principal place of business
Duration of the LLC
Management Structure:
Who makes business decisions
Authority levels for different types of decisions
Record-keeping requirements
Financial Provisions:
How profits and losses are handled
Capital contribution requirements
Distribution procedures
Banking and financial management
Transfer Restrictions:
Conditions under which membership can be transferred
Right of first refusal provisions
Valuation methods for ownership interests
Dissolution Procedures:
Events that trigger dissolution
How assets will be distributed
Wind-up procedures
Miscellaneous Provisions:
Dispute resolution procedures
Amendment processes
Governing law clauses
Common Mistakes to Avoid
Using Generic Templates: Downloaded templates rarely address your specific business needs and state law requirements. They often contain provisions that don't make sense for single-member LLCs or create unintended consequences.
Forgetting to Update: Your operating agreement should evolve with your business. Major changes in operations, location, or business focus should trigger a review and potential update.
Ignoring State-Specific Requirements: LLC laws vary significantly by state. An operating agreement that works in Delaware might not be appropriate for Massachusetts.
Overlooking Tax Implications: Your operating agreement should align with your tax elections and planning strategies. Inconsistencies can create problems during IRS audits or state tax reviews.
The Cost of Not Having One
I've seen the consequences when single-member LLC owners skip the operating agreement:
Financing Delays: A client lost a favorable loan rate because the bank required an operating agreement before closing, and rates increased during the delay.
Insurance Claim Denials: An insurance company initially denied a claim because they couldn't verify who had authority to purchase the policy without an operating agreement.
Partnership Disputes: When a business owner wanted to add a partner, negotiations stalled because there was no existing framework for bringing in new members.
Sale Complications: A buyer almost walked away from a business acquisition because the lack of an operating agreement raised questions about how the business had been managed.
Making the Investment
Yes, having a proper operating agreement drafted costs money upfront. But consider it business insurance. The cost of creating one is minimal compared to the potential problems and lost opportunities you'll face without it.
More importantly, a well-drafted operating agreement can actually save you money by:
Preventing financing delays
Streamlining future business transactions
Reducing legal complications
Demonstrating business professionalism to partners and lenders
The Bottom Line
Your single-member LLC operating agreement isn't just a document for you - it's a business tool that numerous parties will rely on throughout your company's life. From banks and insurance companies to future partners and buyers, many people need to understand how your business operates.
Don't wait until someone asks for it to realize you need one. By then, you've already missed opportunities and potentially complicated important business transactions.
Think of your operating agreement as your business's foundation. You might not see it every day, but everything else you build depends on it being solid and properly constructed.
This article provides general information and should not be considered specific legal advice. Operating agreement requirements vary by state and business situation. Consult with a qualified attorney for advice specific to your LLC.
Serving small businesses and solo professionals throughout Southern Massachusetts, including: Bristol County (Attleboro, Fall River, New Bedford, Taunton, North Attleborough, Mansfield, Norton, Easton, Raynham, Rehoboth, Seekonk, Swansea, Somerset, Westport, Dartmouth, Fairhaven, Acushnet, Berkley, Dighton, Freetown), Plymouth County (Brockton, Plymouth, Quincy, Weymouth, Braintree, Marshfield, Scituate, Hingham, Cohasset, Hull, Whitman, Hanson, Halifax, Kingston, Duxbury, Pembroke, Hanover, Norwell, Rockland, Abington, East Bridgewater, West Bridgewater, Bridgewater, Middleborough, Lakeville, Carver, Wareham, Marion, Mattapoisett), Norfolk County (Franklin, Wrentham, Plainville, Millis, Medway, Bellingham, Foxborough, Sharon, Stoughton, Canton, Randolph, Holbrook, Avon, Milton, Dedham, Westwood, Norwood, Walpole, Dover, Medfield, Sherborn), Barnstable County/Cape Cod (Barnstable, Falmouth, Mashpee, Sandwich, Bourne, Yarmouth, Dennis, Brewster, Harwich, Chatham, Orleans, Eastham, Wellfleet, Truro, Provincetown), Dukes County (Martha's Vineyard), and Nantucket County.
