What is an LLC Operating Agreement?
An operating agreement is an agreement among limited liability company (“LLC”) Members governing the LLC’s business, and Member’s financial and managerial rights and duties. Many states in the United States require an LLC to have an Operating Agreement. LLCs operating without an Operating Agreement are governed by the State’s default rules contained in the relevant statute and developed through state court decisions. An Operating Agreement is similar in function to corporate by-laws, or analogous to a partnership agreement in multi member LLC’s. In single member LLCs, an operating agreement is a declaration of the structure that the member has chosen for the company and sometimes used to prove in court that the LLC structure is separate from that of the individual owner and thus necessary so that the owner has documentation to prove that he or she is indeed separate from the entity itself.
Limited Liability Companies are very flexible in nature and the operating agreement defines each member or manager’s rights, powers and entitlements. This includes capital accounts, membership interest, distributions of profit and allocated tax responsibility, just to name a few. This internal document is an agreement set by the company members that contains provisions for critical items and rules that run the company. Operating agreements can be amended at any time by the company members or managers.
Forming an LLC, or limited liability company, can be a very attractive option if you’re looking for a business structure with increased personal protection and less formalities. Keep in mind that they do require some additional paperwork, including, an operating agreement. Here are the basics every LLC owner should know about operating agreements:
Why do you need an operating agreement?
To protect the business’ limited liability status: Operating agreements give members protection from personal liability to the LLC. Without that formality, your LLC can look too much like a sole proprietorship or partnership, jeopardizing your personal liability.
To clarify verbal agreements: Even if members have orally agreed to certain terms, misunderstandings can still arise. It is always best to have the operational conditions of your business in writing so they can be referred to in the event of any conflict.
To protect your agreement in the eyes of your state: State default rules govern LLCs without an official operating agreement. This means that each state outlines default rules that apply to businesses that do not sign operating agreements. Because the state default rules are so general, it is not good idea to rely on them for your agreement.
What does an operating agreement look like?
Operating agreements are contract documents that are generally between 5 and 20 pages long.
Tip: Try reviewing sample operating agreements* to get a general idea of what they should look like.
What is included in an operating agreement?
The functionality of internal operations are outlined in the operating agreement including:
Percentage of members’ ownership
Voting rights and responsibilities
Powers and duties of members and managers
Distribution of profits and loses
Buyout and buy-sell rules (procedures for transferring interest when members chose or in the event of a death)
Are LLCs required to form an operating agreement?
The requirement of an operating agreement depends on the state it was formed in. While many states do not require operating agreements, some, such as Missouri and New York, do. This information can generally be found on your secretary of state website.
Tip: It is unwise to operate without an operating agreement even though most states do not require a written document. Regardless of your state’s law, think twice before opting out of this provision!
Where should operating agreements be kept?
Operating agreements should be kept with the core records of your business. They are not required to be filed, nor will they be accepted by your state.