Operating Agreements: What are they & What to Include
When forming an LLC there are a variety of different aspects involved in the formation and continuance of your organization. One aspect of formation when it comes to an LLC is the operating agreement. An operating agreement is essentially a set of rules or guidelines for a business. Although it is not legally required in order to operate, it is highly recommended. This is because it governs how the LLC is run and provides regulation and structure in case a situation arises between members.
When you have guidelines written down in advance it makes it clear to your team and board of directors what their duties are, who makes the decisions, and how the business will be run.
The operating agreement is a key document used by LLCs. This document outlines all of the financial and functional decisions of the business. In your operating agreement, either you or your co-owners will establish the percentage of ownership in the LLC. It will also outline shares of profits and losses as well as what will happen to the business if one of you leaves. This might include rules, regulations, and provisions. The purpose of the document is to govern the internal operations of the business exactly how the owners wish to do so.
How Operating Agreements Work in LLC’s
Although there is never a business that starts with ill intent or the idea that a problem may arise, an operating agreement helps to keep it that way. In some cases, members are liable for actions that go outside of the protections of general LLC liability law. Especially in the case of personally guaranteed debts. An example of a personally guaranteed debt would be a business loan.
Operating agreements help to keep all duties of the LLC members apparent and keep the rules visible for everyone. In the event there is a disagreement, it can help to settle arguments in conversation or even in court.
What Needs to Be Included in an Operating Agreement?
If you are drafting an operating agreement for your limited liability company, you are required to include the following information.
When drafting your company’s operating agreement, make sure to include this information.
The Name of Your LLC
In order to signify which LLC the operating agreement is about, the name of the LLC must be clearly placed within it. This is essential because otherwise it can not be proven nor connected.
Your Company’s Articles of Organization
In order to make connections between the articles of organization and the LLC, these pieces of information should be included in the operating agreement.
The Duration of the LLC
In some cases, an LLC can be conditional. This means although it may be in business for a short period of time, it will not be around forever. This is an indefinite LLC.
Your Company’s Address
You will need to include the operational address of your LLC. This must be either the place of business of your LLC or your personal business address should you run an online business.
Name and Address of Your Registered Agent
Every LLC must have a registered agent. This person or business must have an address within the state of formation of your business. This needs to be included in the operating agreement as well.
Your Business’s Purpose
Every business has a purpose. Whether this is to sell specific goods, provide services, or as a holding company. This must be included in the operating agreement.
Members ownership: In order to start an LLC, each owner will need to contribute something to fund the business. This might include cash, property, or services. LLC owners are given a percentage in exchange for shares. Despite this, members are able to decide on percentage of ownership in any way that they wish to do so. This should be included in the operating agreement.
Responsibilities: Each member in an LLC should have specific responsibilities which are outlined in the operating agreement.
Profit Distributions: Members are given ownership, but this does not correlate to profits. Profits and losses in an LLC are called "distributive shares."
Procedures of transferring interest: If someone within the LLC dies, retires, or sell’s their interests in the company, what happens next will need to be outlined in the operating agreement.
Voting powers: In some cases a vote is necessary to make decisions, and there are two ways to do this, either each vote is according to the percentage of ownership, or each member gets one vote. Either way this must be laid out in the operating agreement.
Management: The management structure should be laid out dictating who manages and who has what roles.
Why Operating Agreements Are Important
There are various reasons why having an operating agreement is important. Operating agreements often are able to prevent disputes between members. The operating agreement can be pulled up to clarify any verbal agreements as well.
Finally, the operating agreement will protect the facts of the agreement legally in court, and even protect the limited liability status of the business. Again, operating agreements are not required in every state but it’s in your best interest to create one. A written document that clearly outlines the duties and responsibilities of your members will help ensure compliance.
Why Do You Need an Operating Agreement?
Protect limited liability status of business
The main reason that you would want to make an operating agreement is to make sure that your personal assets are protected. This comes into play when you are looking to have the courts respect your limited personal liability. Especially if you are a single member LLC, without an agreement, the LLC will look a lot like a sole proprietorship.
Clarify Verbal Agreements
Co-owned LLCs are required to document both the decision and profit-sharing protocols. There should also be documentation regarding what to do in the event of departing members. If there is no operating agreement, you and your co-owners will not be able to settle issues regarding finances and management that were once only verbal.
Protect Agreement in eyes of the state
Each state has laws that set the basic operating rules for LLCs. Some of these may not be what you want your LLC to work off of, and therefore you will need to have it stated otherwise in your operating agreement.
How to Create an LLC Operating Agreement
The requirement of an operating agreement depends on the state it was formed in. Despite this, not all states require one. Having said that, it is important to draft one to protect all members involved. Be sure to consult with an attorney to assist with the legal document.
When writing an operating agreement for your LLC, you should include the following details:
- Company basics: Include company name and address, formation date, as well as registered agent details.
- Member information: Includes member names and contact details, contributions, all rights, and responsibilities, as well as manager/officer details.
- Accounting procedures: When the fiscal year will end, how records will be kept, and any details about profit distribution.
- Other processes: Such as voting procedures, what happens if a member quits or is found incompetent, how and when the LLC may be dissolved.
Should I Have an Operating Agreement?
It is very important to have an operating agreement for an LLC. Even if your business is set up as a holding company or a regular LLC, this can prevent a lot of trouble in the future. Operating agreements will protect each member within the organization. Although disagreements are never planned, those between business partners can be ruthless. The operating agreement protects everyone.
It is essential to run your LLC with an operating agreement if you wish to be in charge of your business. LLCs will automatically be governed by state laws if they do not have an operating agreement, which can take control from the hands of the members.
Essentially, the operating agreement ensures that all formalities are completed and that the roles are defined within the organization. You will never question the obligations of each member, and the LLC will be a clearly defined entity in the eyes of the law.