What is an Operating Agreement?

Operating agreements are contracts between LLC members that provide information on how the company will operate. Unlike Articles of Organizations, operating agreements do not need to be filed with the state. Although they are not filed, they are still legally enforceable documents. 

What are the Standard Provisions Included in an Operating Agreement?

Operating agreements can be short and to the point. Typically, there is a list of standard provisions to include when drafting the agreement. 

General information about your business should be included in your operating agreement. This information will be the name of the LLC, company address, registered agent information (if applicable), and members.  This information is typically included at the beginning of the operating agreement. 

The operating agreement may also include a few lines about the company’s business purpose. This will sum up the business’s industry and primary services and/or products. Other standard provisions are included below.

  1. Percentage of Ownership

    The percentage of ownership is the amount each member has in the business. Your operating agreement will lay out the percentage of ownership so there is no confusion.

    For a single-member LLC, the member will have 100% ownership. In a multi-member LLC, this number can vary. The percentage of ownership will total the number of funds that are invested in the LLC. This is also the same percentage for distributions.

  1. Management Structure and Roles

    When forming the LLC, it can be structured as manager-managed or member-managed. The former will allow members to choose individuals to run the business. The latter is where all the members operate the business themselves, equally.

    In an IRA LLC, your entity should have a designated manager and be manager-managed. This section will also describe the roles, responsibilities, and duties of the manager(s). 

  1. Decision Making

    Most operating agreements lay out how the decisions of the LLC will be made and how voting will be determined. It should be identified if there needs to be a majority or unanimous outcome. Many states implement a default ruling that decisions will be proportional to ownership percentages. Allowing your business to determine who has the decision-making authority can prevent management disputes down the line. 

  1. Bookkeeping and Records

    LLC members are required to maintain records and bookkeeping for the business. This provision should outline whose responsibility it is to maintain these documents as well as where they will be stored.

  1. Dissolution

    Providing detail on how the business will dissolve is important. The operating agreement can establish the protocol and events which can trigger dissolution. There can be sub-sections included such as equity transfer, dispute-resolution agreements, or anti-dilution protections. Consideration should be given to this provision in case the unthinkable or unwanted happens. 

  1. Tax Treatment

    In most situations, LLCs are taxed as disregarded entities.This means that the LLC does not file business tax returns. Member(s) report their share of the business profits and losses on their own personal taxes.
    LLCs can however elect to be taxed as a S-Corp or C-Corp by filing with the IRS. Members can add the preferred tax treatment to the operating agreement.

    Operating agreements should be viewed as living documents. Amendments and changes can be made to tailor the operating agreement to the business’s needs. 

Why Do I Need an Operating Agreement for my Company?

You may be asking yourself, “why do I need an operating agreement for my company?” There are many great reasons listed below.

Avoid the State “Default Rules”

Owning a business gives you the advantage to have some control over how the business operates. States provide their own set of rules, “default” rules, that govern when companies omit to have something in place. These default rules are very general in nature. An operating agreement allows the company to have a set of rules in place that may be beneficial than the states’ rules.

For example, sometimes there is no documentation regarding the succession of the LLC in case a member passes or becomes indisposed. In most states, the default rule passes the LLC to the next of kin. This is in place to protect the LLC. However, sometimes the next of kin is not equipped to manage the LLC and its assets.

Putting these provisions in place within an operating agreement will ensure the LLC is properly managed or passed down.

Protect the Limited Liability Status of Owners

Describing the operations of the LLC within an operating agreement can protect the limited liability status of the owners. This means the owner is protected as long as they act within the guidelines of the operating agreement. In some circumstances, owners can still be held liable for their actions as “limited liability” does not mean “no liability”. 

Prevent Management Disagreements for my LLC

Laying the foundation of how the business will operate can prevent disagreements or disputes down the road. Most people start or go into business with family or friends. This scenario tends to leave members less guarded than if they would be going into business with a business partner.  The voting rules, contributions of members, distributions, and termination of business can all lead to disagreements or conflict. 

Operating agreements can detail those provisions for all members to agree on from the start. 

Single-Member LLCs

You may think it unnecessary to have an operating agreement for your single-member business. Establishing an LLC can heighten your credibility, and so can an operating agreement. It can show investors you are a professional business and you have plans in place for any mishaps or issues. Also remember that an operating agreement is a legally binding document. Having this agreement can be beneficial and used to establish your business is a separate entity from yourself. 

Lending a Helping Hand

It is important to consider the benefits of an operating agreement for your LLC. It provides a great deal of protection for the business and its members.