Business is not just about deals. For your company to flourish, you need to keep it running every day by making decisions quickly and adapting to change.
If you are planning to start an LLC or are already conducting business, you may have heard of an Operating Agreement. This document is not required in most states, but lawyers and experienced entrepreneurs insist on having one. Why? What is this document and its role? In this guide, we will answer these questions.
What is an Operating Agreement?
- What is an Operating Agreement?
- Which Type of LLC Operating Agreement Do I Need?
- Why You Should Have an Operating Agreement
- What Should Be Included in an Operating Agreement for an LLC
- Drafting an Operating Agreement
- How Do You Change Your Operating Agreement?
- In Conclusion
Operating Agreement is a document that establishes such important aspects of the company’s activities as:
- Management structure;
- Rights and duties of the participants;
- The principles of work, etc.
Most states do not require to create this document. However, having one is essential for the stable existence of the company.
First-time entrepreneurs often confuse the Articles of Organization with the Operating Agreement, which are two completely different documents.
The Operating Agreement is an internal document of the company. It does not have a legal nature like the Articles of Organization, therefore it is not subject to registration and does not require to pay any state fees.
Which Type of LLC Operating Agreement Do I Need?
An LLC can be founded by a single or a number of owners. Depending on this, this document will be slightly different.
An Operating Agreement for a multi-member LLC
If an LLC has two or more members, you must indicate in the official paper how it will be managed. There are two options available:
An operating agreement for a single-member LLC
At first glance, drafting an Operating Agreement for a single-member LLC may seem like a waste of time, but it is not. You will never have a management disagreement with yourself, but this document is not limited to management only.
It covers such important points as:
- Separating your personal assets from the company assets;
- Establishing the LLC as a separate legal entity.
In addition, the structure of your single-member LLC may become more complex in the future by joining new members, so you should not neglect the Operating Agreement.
Why You Should Have an Operating Agreement
Regardless of whether you decide to start a multi-member or single-member LLC, putting an Operating Agreement gives the company benefits like:
- Clear management structure: once you’ve established the role, rights and duties of the participants in the LLC Operating Agreement, you can forget about misunderstandings regarding management issues;
- Smooth running: this legal paper outlines the procedures that ensure the efficient work of the company. It can also serve as a guide for determining procedures:
- Membership Changes;
- Capital Contributions;
- Distribution of funds: a written agreement on how losses and profits are to be distributed, to avoid conflicts between participants;
- LLC status protection: the Operating Agreement is a further confirmation you are operating as an LLC, not as a sole proprietorship or partnership;
- Ability to avoid “default rules”: any issues not covered by this official document will be governed by state law. It does not take into account the specifics of any particular company and therefore is not always beneficial. Moreover, if you conduct business in several states, it may be subject to different “default rules”. That’s why it’s important to draft an Operating Agreement in detail to cover as many different situations as possible;
- You can provide a written Operating Agreement to:
- Potential partners or investors to confirm the credibility of the company;
- The bank to get financing;
- A lawyer or accountant to consult with, etc.
What Should Be Included in an Operating Agreement for an LLC
Because it is an internal and optional document, the state does not provide an official Operating Agreement form. Nevertheless, drafting an effective agreement is not as difficult as it might seem at first glance. Its volume and structure are totally determined by the needs of the business and the preferences of its owners.
Of course, every Operating Agreement is unique as well as the business. However, there are a few basic points that should be settled in this document:
- Articles of Organization: date of registration, state, etc.;
- Duration of the LLC: whether the company will operate until the date of filing a dissolution application or until a certain date;
- Name and address of the Registered Agent;
- The purpose or nature of the business.
- Names of the initial members;
- The amount of their contribution and ownership interest (percentage);
- How new members make initial capital contributions and the required amount per member;
- How members receive the profits and losses each year.
Management of the LLC
In this part you need to compare the two types of management of your company, Member-Managed LLC vs. Manager-Managed LLC. Once you have considered the advantages and disadvantages of all of them, you can determine who will be in charge of the day-to-day work of the LLC, the owners or the managers.
When choosing a member-managed structure, do not forget to clarify such details as:
- Voting procedure;
- How many members form the quorum required to make decisions;
- On which issues a unanimous decision is necessary, and when a majority vote is sufficient;
- Is there a remuneration for fulfilling management responsibilities and its amount.
If you want professionals to take care of your company, then you should provide in the agreement:
- The procedure of choosing and appointing managers;
- Rights and duties;
- Working period;
- The amount of remuneration, etc.
Provisions for Leaving or Ending the LLC
- When and how a member can leave the LLC;
- Under what circumstances and how a member can be asked to leave the LLC;
- The process for buying back or transferring a member’s interest;
- Liquidation procedures and distribution of member property.
Although an LLC provides protection to its owners, they can sometimes be liable for the actions of their partners. Considering this, it is a good idea to include an indemnification clause in the Operating Agreement.
Since the volume and content of the Operating Agreement is unlimited, you can also include a number of additional points such as:
- Processes for how to amend the agreement;
- A non-disclosure agreement;
- A non-compete agreement, restricting members from joining competing businesses.
Pay attention to the fact that the rules established in the Operating Agreement must not contradict the law. For example, if you try to state that your company should not comply with the requirement to provide annual reports, these rules will not be legally binding.
Drafting an Operating Agreement
As a rule, most companies prepare an Operating Agreement at the formation stage. However, with the prior approval of the other co-owners, you can draft it at any time.
Depending on your preferences and budget, there are several different ways to write an Operating Agreement LLC:
- Hiring an attorney;
- Hiring an online service;
- On your own, using templates available on the Internet.
Although hiring an attorney is the most expensive option, it guarantees you a high-quality, carefully prepared document. A professional attorney will help you understand the specifics of the business and state law to prevent most situations that may arise in the future.
Some specialists work at a flat rate, while others charge by the hour. You can also hire a lawyer to check and correct the text of the agreement. The cost of attorney service usually depends on their location, experience and skills and range from a few hundred to a thousand dollars.
Compared to hiring a lawyer, online professional services can save your money and provide high-quality results. When you purchase an LLC formation package, some services also offer customized templates.
Using a template from the Internet is free. However, most of them have one thing in common – the lack of uniqueness. They are focused on a wide range of companies and do not take into account the specifics and business goals of each company.
Every option has its advantages and disadvantages. No matter which one you choose, but it is important to change an Operating Agreement on time.
How Do You Change Your Operating Agreement?
Since an Operating Agreement is an internal company document, there are no difficulties in amending it. If you foresaw that in this document, just follow the pre-designed procedure. If your document does not have that clause, then you have to follow state legislation.
The first thing you should do to keep your Operating Agreement up to date is to draft the amendment and put it in the written document. Be sure to make the wording as clear as possible to avoid possible ambiguities.
The next step is for the members to approve the changes. This involves printing the new Operating Agreement and sending its copy to each of the LLC owners for approval. Depending on the state, it may be a majority or unanimous vote.
As soon as the owners sign the Operating Agreement, it becomes effective. You don’t need to send this document to a specialized state agency for registration. Instead, you should simply keep it with the other papers.
So we have covered the key points regarding the Operating Agreement, including its content and purpose. Although this document is not mandatory in most states, the advantages of having this legal paper for LLC are obvious. It is an important document, required for both single-member and multi-member LLCs. To provide a stable running and steady growth of the business, you need to take care of the Operating Agreement preparation during the LLC formation process.
The Operating Agreement does not include any official requirements besides signatures of the LLC members, but you have to be very careful about its preparation. This has a direct impact on the quality and effectiveness of the document and, consequently, on the work of the LLC. If you have any doubts about drafting it, consult a lawyer or registered agent to get the most out of it.