Since business ownership is such a key point of conversation with so many of our clients, we’ve been writing a series of articles about business organization—all the stuff that doesn’t seem very exciting but is essential to legally own a business and creating a “corporate veil” between your assets and you.
So, you’ve researched and registered your entity name and decided what kind of corporate entity fits for you and your company. And if you choose to structure your business as a Limited Liability Company (LLC) then you will need to draw up an operating agreement.
An operating agreement is similar to articles of incorporation but specifically designed for use by LLCs.
In some ways, an operating agreement functions similarly to a prenuptial agreement. Operating agreements are a way to manage disagreements in the event legal matters arise between business owners. When an operating agreement is in place, courts have provisions to refer to in helping arbitrate or otherwise bring the dispute to resolution.
What’s in an Operating Agreement?
An operating agreement lines out ownership and member duties as they relate to the LLC. A typical operating agreement will be structured like this:
- Article 1: Organization – Specifics about when the company was created, ownership structure, and membership.
- Article 2: Management and Voting – Pretty self-explanatory: management structure, who has a right to vote on business decisions, and how voting will happen.
- Article 3: Capital Contributions – This is the “skin in the game” that each member will be required to have in exchange for a percentage of the company, along with how other funds will be raised.
- Article 4: Distributions – This section describes how the company’s profits and losses are shared among members.
- Article 5: Membership Changes – People move on and things change. You need a process for handling membership changes.
- Article 6: Dissolution – This section covers what happens when it is decided, or necessary, to dissolve the company.
Where Do You File an Operating Agreement?
There is actually no requirement that an operating agreement be filed with your Secretary of State. So an operating agreement should be kept with other important legal documents where it can be referred to as needed.
We’re all Good Pals. Do We Really Need an Operating Agreement?
Your partners are often good friends, or at least people you know well and trust. But even the best relationships can get tested when it comes to money. So an operating agreement gets everything out in the open, so there are fewer ways to miscommunicate about how the business will run and who will be making decisions.
Beyond that, operating agreements give members protection from personal liability to the LLC. Without this document—even though it’s not required by the state—your LLC might look, from the outside, very similar to a sole proprietorship or partnership. An operating agreement is an extra hedge against personal liability – all in all, a pretty important document.