Operating Agreements 101
What is an operating agreement?
- A document exclusively used in the formation of LLCs; an operating agreement is specifically used by LLCs.
- Outlines the duties, obligations, and responsibilities of the LLCs members.
- Outlines the rules and regulations LLC members must abide by.
- Outlines how disputes among LLC members will be handled.
- Outlines the financial functions and decisions; the “internal organization” of the LLC.
- Signed by all LLC members; operating agreement becomes binding once signed by the members; members will be bound to the operating agreement’s contents.
- Can be explained as a “contractual” point of authority.
Why are operating agreements important?
- Three most important reasons to have an operating agreement:
- Can forfeit limited liability; partnerships and LLCs bear a strong resemblance, operating agreement, because specific to an LLC, can be the only factor that spares an LLC from being deemed a partnership.
- Operating agreements aren’t required to be in writing, but should be put in writing anyways; the existence of an oral operating agreement could be hard to prove, can be difficult to prove that all members agreed, etc. Needed for the purpose of preserving the agreement itself.
- Only real way to avoid the state’s LLC “default” rules. Providing more flexibility, members can formulate rules that fit their personal preference and business needs; however, the agreement can’t be illegal or inconsistent with public policy, etc.
What should an operating agreement include?
- Some states don’t require operating agreements at all. However, this doesn’t mean one should not be made.
- States will vary as to the terms they require to be included in an operating agreement.
- Operating agreements are not required to be filed with the state; the state will not accept them.
- Operating agreements should be kept alongside the LLCs business records; operating agreements should be kept confidential.
- Typical terms found in an operating agreement:
- How losses and profits will be split.
- Ownership percentages
- Voting rights of members.
- Rules by which the members must abide.
- Powers and responsibilities of members and/or managers (if manager-managed rather than member-managed).
- When meetings will be held.
- Buy-sell provisions.