What Is an Operating Agreement?
An operating agreement is a document used by limited liability companies to set forth its rules, regulations, and decision-making processes. It outlines the operations of the business in a way that suits the specific goals of the LLC’s owners, and serves as an official contract binding them to its terms.
Whether an operating agreement is required for your LLC depends on the state in which it was formed. Nonetheless, it is highly recommended that you have one in place in order to avoid issues down the line.
Why is It Smart to Have an Operating Agreement?
- To ensure that the governing rules are tailored to your specific business operations: If an LLC doesn’t have an official operating agreement in place, state default rules govern its operations. Often times, a state’s default rules are very general, and may not contain all of the details and provisions necessary for your particular business. Therefore, it is important to have a formal document in place that governs your company’s specific goals and needs.
- To preserve limited liability status: One of the great perks of running your business as an LLC is the protection from personal liability that is afforded to you and your members. Having a formal operating agreement in place memorializes this protection. If you are operating without one, it can be argued that your LLC more closely resembles a sole proprietorship or partnership—which can jeopardize you and your members’ personal liability.
- To memorialize terms, and avoid future conflict: In many cases, LLC members verbally agree to certain terms and/or rules that will govern their business. They may be close friends or even family, so often they don’t think twice about having a simple “handshake” understanding regarding how operations will run. However, miscommunications frequently take place, which can result in disagreements and even litigation. To avoid this, it is highly recommended that you put the governing provisions and decision-making processes of your LLC in writing, so they can be referred to in the event of any issues. Having a formal operating agreement can save massive headaches down the line in this regard.
What is Included in an Operating Agreement?
Some of the items that are outlined in an operating agreement generally include (but are not limited to):
- Ownership interests;
- Limitation of Liability;
- Powers and responsibilities of members and managers;
- Distributions of profits and losses;
- Restrictions on transfer;
- Dispute resolution;
- Liquidation and dissolution; and
- General provisions