What is a One Member LLC Operating Agreement?
The operating agreement of an LLC serves a very specific purpose for the business and the owners. In a single-member or "one-owner" LLC, the operating agreement lays out in detail how the company will be run. In addition, the operating agreement will establish the authority the owner has as a member and what he or she can or cannot do with the company’s assets.
The operating agreement of a Colorado LLC that has only one owner or member will also include what will happen to the LLC if the owner dies. In many cases, a recent or future spouse’s inheritance rights are protected or eliminated, even if the LLC operating agreement will not change hands .
A single-member LLC operating agreement is generally not required by Colorado LLC law. However, such an agreement is very useful when the owner has other assets or interests that he or she needs to protect.
In the event of a divorce or other bankruptcy proceeding, the single-member LLC operating agreement will work very similarly to a trust in that what the owner has placed in the single-member LLC will be difficult, if not impossible, for his or her estranged spouse, former spouse or legal creditor to access. The operating agreement will also protect the assets of the owner from frivolous claims or lawsuits.
Advantages of a Single Member LLC Operating Agreement
While the law does not require a single member LLC in Colorado to have an operating agreement (or a different written agreement) detailing its operational structure, the fact that the law does not require such an agreement should not prevent you from having one. Just because the law does not require you to do something does not mean it’s not a good idea to do it anyway.
One of the primary benefits of an operating agreement for a single member LLC is protecting assets from business creditors. If you have an LLC and do not maintain accounts or any other assets separately from your personal assets or activities, you may as well not have an LLC. If someone is injured by your business or otherwise has a claim against your LLC, the injured party may be able to come after your personal assets (real estate, bank accounts, vehicles, etc.) if they can demonstrate that there is not a meaningful separation between your company and yourself.
Another benefit of an operating agreement for your single member LLC is clarifying who has authority to make decisions about your business. In some states, if you do not have an LLC operating agreement or other written agreement, the law automatically gives that authority to the LLC manager. If there is more than one manager of your single member LLC, that could create confusion as to who has the final say in making decisions for your company, which could, among other things, create potential liability for the LLC manager who acts without the agreement or authorization of the other managers.
While it may seem strange for a single member LLC to have a formal agreement on how decisions are made, even if that member is a corporation or other business entity, the law does provide for the method of determining who has that authority if there is no formal agreement is. If you would prefer to have more control over how decisions are made for your LLC, and who can make decisions on behalf of your company, you should consider preparing an LLC Operating Agreement.
A perhaps less obvious benefit of having an LLC Operating Agreement is that it can address how your business assets should be disposed of upon the death of the person who is the only member of the LLC. If an LLC member dies without a written agreement in place designating a successor, the manager has sole authority to determine what happens to the deceased member’s interest. The manager may choose to maintain the LLC, causing a potential increase in tax liability to the estate (or the manager, if they are not an heir). The manager also could choose to sell the company, causing a reduction in taxable value of the estate while increasing the probate liability. If the single member is a corporation, they may wish to liquidate the interest, which for federal income tax purposes, would be a complete liquidation of the interest with the value included in the estate of the deceased member.
Colorado Requirements
In Colorado, the legal requirements for creating a single-member LLC are fairly straightforward, but there are certain aspects that must be clearly laid out to ensure that the business is legally compliant. To create a single-member LLC in Colorado, one must file the Articles of Organization with the Secretary of State’s office and pay the required filing fee. The Articles of Organization must include the name and address of the LLC, the registered agent’s name and street address for service of process, the name and address of the LLC organizer, the signature of the organizer, and the business address. As with all business structures, however, there are certain protections and assurances only a properly drafted Operating Agreement can provide.
Even though the Operating Agreement for an LLC is not a required document, filing one will mean that neither the members nor the managers thereof will be personally liable for any debts or liabilities, except in certain cases where they are acting as directors, officers, agents, members, or partners. Using a standard form for an Operating Agreement can result in gaps in protection or in specificities that may unnecessarily restrict managers or the members themselves, such as having large amounts of required capital contributions, or mandates about future capital contributions. These are business decisions that should be made on a case-by-case basis, so a tailored operating agreement can provide managers and members of a single-member LLC and greater peace of mind.
The Colorado LLC Act does not require that the LLC have any records or documentation; however, these corporate records do bring owners peace of mind in managing the LLC. The business records policy should state that the LLC follows the Colorado LLC Act and having the director and/or officers make periodic reports on the LLC’s progress will mean the court has protected the LLC with the proper documentation if there is ever a need to enforce a right or defend against a claim.
Provisions of a Colorado One Member LLC Operating Agreement
A single-member LLC operating agreement is a core component for a single-member LLC operating in Colorado because it clearly outlines business details, such as the structure, management and operation of the business. In the absence of an operating agreement, procedures and policies can be dictated by the Colorado LLC Act, which is not always in the best interest of a single-member business. The following is a list of key elements to include in your single-member LLC operating agreement:
Ownership
The agreement should express the ownership of each membership interest in the LLC. For example, if the ownership interest is equally divided among five members, each member’s name and ownership percentage should be clear within the instrument.
Management
Every LLC in Colorado has to designate some form of management overseer, even if there is only one member. Generally speaking, there are two avenues a single-member business can take in its management. (1) It can choose the sole member to run the business (which is the default choice), or (2) the business may designate a manager to operate the LLC.
Bank Accounts & Finances
A single-member business should include banking information — including the designated banking institutions — and a secure means of holding LLC funds. For instance, you may want to prohibit personal use of company funds using language that requires for-profit expenditures only.
Resolution of Conflicts
A common and necessary element of an operating agreement is the method of conflict resolution for any disputes arising amongst members about business operations and management. The boilerplate language typically states that the resolution will occur according to the terms of the operating agreement; however, language is still needed within the agreement to settle a dispute, should one arise.
How To Create an Operating Agreement
Steps to Draft a Single-Member LLC Operating Agreement
In Colorado, the operating document provided for limited liability companies is governed by the Colorado Limited Liability Act. The Act is located in Title 7, Article 90 of the Colorado Revised Statutes. Every Colorado LLC must have an operating document, whether written or oral, that governs the functioning of the LLC. However, if there are no restrictions in the Articles of Organization or the operating document, the provisions set forth in the Colorado Revised Uniform Limited Liability Company Act will govern the LLC and control.
The operating document generally sets out the rules that establish how the affairs of the business entity will be handled. In particular, for a single-member entity, it sets forth the rules for member meetings and management. The basic steps to drafting such a document may include:
Determine whether the Colorado LLC Operating Agreement will be a formal or informal document.
Select the appropriate name for the formal Colorado LLC Operating Agreement.
Complete the Colorado LLC Operating Agreement .
Arrange for a proper signature.
Store the Colorado LLC Operating Agreement in a safe place within the LLC’s files.
Note that regardless of its name, even an informal Colorado LLC Operating Agreement needs to contain several key elements, including:
The rights of all members of the LLC,
The bases on which members can be admitted,
The voting process within the LLC,
The amendments process for the Operating Agreement,
The additional steps necessary for transferring membership interests to third parties,
The conditions under which membership can be terminated and the procedures necessary to accomplish that action,
The procedures for liquidation,
The method of distributing proceeds from liquidation,
A description of any contribution requirements to the LLC,
The procedures for resolving disputes within the membership,
The appointment of officers, managers and other agents for the LLC,
The remuneration for officers, managers and other agents of the LLC,
The place of maintenance of records for the LLC, and,
Any other provisions that you deem necessary for your Colorado LLC.
Keeping Your Documents Fresh
While your business is a "single-member" entity, it is important to continue to review and even amend your operating agreement over the life of your business. What may have been a great idea at the start may not be applicable in the future as your business grows and as your personal or business situation changes. Additionally, your operating agreement may need to be updated as tax laws or rules change, to reflect a change in your existing ownership or to reflect the opening of an additional location. To the extent that your LLC has taken on new members (due to the divorce of a member or the death of a member), your operating agreement may need to be updated to account for changes in ownership or to limit or require that the transferee(s) abide by certain terms. Amendments to single-member operating agreements should be as detailed as possible so future owners are aware of all prior changes. The amended or restated operating agreement can be attached to your original operating agreement. An excellent practice is to always provide a copy of the amended operating agreement to your accountant, so your business can operate as seamlessly as possible.
What Are the Common Mistakes
Mistake #1: Failing to Address Future Members
If there is a chance you will bring in additional members during the lifetime of your single member LLC, you need to plan for that possibility from the beginning. The Colorado Limited Liability Company Act has a default order of operations that will govern your LLC unless you state otherwise.
To avoid future surprises, explicitly state in your agreement how new members will buy-in or otherwise contribute to the company. The more detail, the better.
Mistake #2: Leaving Out a Vesting Schedule
Even if you are the sole owner of your LLC, it is very important to include a vesting schedule in your operating agreement. This will ensure that if you decide to start another business, or divvy up the control of the company later on, you can do so without the hassle of re-issuing membership interests.
Mistake #3: Ignoring or Improperly Delegating Decision Making
While you may want extensive or total control over everyday business decisions, that does not mean you should give yourself sole authority over every decision.
Instead , your agreement can create "ordinary" and "extraordinary" decisions. "Ordinary" decisions are day-to-day decisions that require little oversight. "Extraordinary" decisions would include things like distributing profits, selling the company, or a large purchase.
Mistake #4: Not Considering Profits and Losses
Even seemingly simple LLCs have complex tax issues, which can vary by state and business structure. This is the main reason you need to address exactly how profits and losses will be allocated.
We could explore this topic for pages and pages, but the critical point to remember is that profits aren’t always equally tied to the value of the business or the number of members. You may not be able to divide profit and loss based on pro-rata shares. That is why it is especially important to consult with an attorney or CPA when determining how profits and losses will be divided.
Mistake #5: Not Including Deadlock Provisions
It may seem silly in a single member LLC, but deadlock provisions can save you wasted time and money if you ever find yourself at an impasse. They should account for the top three or four ways members can get into a deadlock and explain how disagreements will be resolved when they occur.