All businesses need a certain degree of structure to function effectively, but some are less formal than others. For instance, a limited liability company (or LLC) offers personal protections from liability but is less formal than a corporation or a partnership.1 Yet even a comparatively informal company structure still needs clear operational guidelines. The most common option in this case is an LLC operating agreement.
What Is An Operating Agreement?
An operating agreement is a document used by limited liability companies to outline and customize the terms of the companies’ operations according to the specific needs of its owners. This includes all financial and functional rules, regulations, or provisions.2 It also outlines the overall structure of companies’ management and ownership. The purpose of the document is to govern the internal operations of the business in a way that suits the specific needs of the business owners.3 Once the document is signed by all members of the LLC, it acts as an official contract binding them to its terms.
What Should You Include In An Operating Agreement?
While the details of an operating agreement will come down to your organization’s specific needs, certain information is expected to be included in every operating agreement. Your document should include the name of the LLC, information on the Article of Organization that you signed with your state, the duration and purpose of the business, the address of the LLC’s principal office, and the name and address of the LLC’s Registered Agent.4 This information should all be included in the introduction of the agreement.
Along with this basic information, there are a few key topics that must be included in any operating agreement:5
- Organization of the Company: Covers when the company was created, who the members are, and the structure of ownership.
- Management and Voting: Covers how the company is managed, how decisions are made, and what powers or duties members and managers have.
- Meeting Requirements: Covers how and when meetings are to be held.
- Capital Contributions: Covers which members have given money to start the LLC, along with how additional money will be raised by members.
- Distributions: Covers how the company’s profits and losses are shared among members.
- Membership Changes: Covers the process for adding or removing members, along with how members can transfer their ownership of the company.
- Dissolution: Covers the circumstances in which the company can or must be dissolved.
Along with this essential information, an operating agreement can also include various other clauses, policies, and amendments to cover specific situations. This can include things such as liability clauses, non-compete or non-disclosure agreements, and conflict of interest policies. Beyond the basics, an operating agreement should cover any matters that could be potentially relevant to a company’s operations.
Why Do You Need An Operating Agreement?
As of 2021, only five U.S. states legally require an LLC to have a written operating agreement: California, Delaware, Maine, Missouri, and New York. That said, while most states do not require one, it is generally a bad idea to operate without an operating agreement in place. An operating agreement helps to clearly establish member’s protections from personal liability. Without a formal document in place, an LLC can closely resemble a sole proprietorship or partnership, jeopardizing member’s personal liability and putting their personal finances at risk. Additionally, if you do not sign an operation agreement, your LLC will be governed by your state’s default laws, which tend to be so broad that they aren’t well-suited to dealing with the nuisances of regular basis operations.6
Simply put, while only a few states require to have an operating agreement, there are no benefits to going without one. Going that extra mile ensures that you are making the most of your company’s legal status and positions you for both financial safety and business success. So if you’re planning to form an LLC, it is vital that you consult a legal professional and write an operating agreement.
1. U.S. Small Business Administration. (n.d.). Choose a business structure. U.S. Small Business Administration. https://www.sba.gov/business-guide/launch-your-business/choose-business-structure.
2. U.S. Small Business Administration. (n.d.). Basic Information About Operating Agreements. U.S. Small Business Administration. https://www.sba.gov/blog/basic-information-about-operating-agreements.
3. U.S. Small Business Administration. (n.d.). Basic Information About Operating Agreements.
4. Murray, J. (2019, November 6). What Should I Include in an LLC Operating Agreement? The Balance – Small Business. https://www.thebalancesmb.com/what-is-an-operating-agreement-for-an-llc-398645.
5. U.S. Small Business Administration. (n.d.). Basic Information About Operating Agreements.
6. U.S. Small Business Administration. (n.d.). Basic Information About Operating Agreements.