Operating Agreement Definition

What Is an Operating Agreement?

An Operating Agreement is a legal document that outlines the ownership and member duties of a Limited Liability Company (LLC).

REtipster does not provide legal advice. The information in this article can be impacted by many unique variables. Always consult with a qualified legal professional before taking action.

What Is the Purpose of an Operating Agreement?

An Operating Agreement lays out the framework for how the LLC will be run, including the responsibilities of each member, voting rights, profit, loss distribution, and other operational details.

The purpose of an Operating Agreement is to govern the company’s internal operations in a way that suits the specific needs of the business owners. While not all states require an LLC to have an Operating Agreement, it is crucial for an LLC as it can help prevent misunderstandings by setting clear expectations about partners’ roles and responsibilities.

Key elements of an Operating Agreement typically include:

  1. Organization: This details when and where the company was created, who the members are, and the business’s ownership structure.
  2. Management and Voting: This outlines how the company is managed and how the members vote.
  3. Capital Contributions: This details which members financially support the LLC and how more funds will be raised in the future.
  4. Distributions: This outlines how the company’s profits and losses are shared among members.
  5. Membership Changes: This section describes the process for adding or removing members and what happens in the event of a member’s death or incapacitation.
  6. Dissolution: This outlines the circumstances under which the LLC may be dissolved.

Creating an Operating Agreement provides a clear guide for how the business operates and helps protect the business’s limited liability status by showing that the business is a separate entity from the owners.

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How to Create an Operating Agreement

There are many different online services that can assist in creating a simple Operating Agreement. One such service is Rocket Lawyer. This video explains how it works.

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Create Your Operating Agreement!

Creating an Operating Agreement for your LLC involves several steps. Here’s a basic guide:

  1. Gather Information: You need to know the details about your business, including the name, principal place of business, member names and their capital contributions, ownership percentages, management structure, and how profits and losses will be distributed.
  2. Choose a Format: Operating Agreements can be written in any format, but most people use a standard legal document format. This makes the document look professional and ensures it’s easy to read.
  3. Write the Agreement: Start by outlining the topics you need to cover. These will likely include sections for the company’s organization, capital contributions, management and voting, distributions, membership changes, and dissolution. Write each section in detail, as clear and specific as possible.
    • Organization: List the LLC’s name, principal place of business, the purpose of the LLC, and the term (if not perpetual).
    • Capital Contributions: Outline who has provided funds, property, or services to start the LLC and their corresponding ownership interest.
    • Management and Voting: Specify whether the LLC is member-managed or manager-managed, and explain the voting rights of members.
    • Distributions: Describe how profits and losses are divided among members.
    • Membership Changes: Specify the process for adding or removing members, what happens upon a member’s death or incapacity, and how the transfer of membership interest should be handled.
    • Dissolution: Detail how and when the LLC will end or under what conditions it might end.
  4. Review the Agreement: After you’ve written the agreement, review it carefully. Look for any areas that may be ambiguous or unclear.
  5. Get Legal Advice: If possible, have a lawyer review your agreement. While this isn’t strictly necessary, it can help ensure that you’ve covered all your bases and that the agreement is legally sound.
  6. Sign and Store the Agreement: Once you and the other members are satisfied with the Operating Agreement, you should each sign a copy. Store it in a safe place and make sure all members have a copy.

Operating Agreements are living documents that can change as your business grows. They should be reviewed regularly and updated as necessary.

Note: This guide is for general informational purposes and may not suit your business needs. Always consult with a business lawyer for personalized advice.

Operating Agreement FAQs

What happens if an LLC doesn’t have an Operating Agreement? If an LLC does not have an Operating Agreement, it will be governed by the default state laws pertaining to LLCs. These default rules may not be suitable for the specific needs of the LLC members and may lead to operational difficulties or disagreements.

Can an Operating Agreement be changed? Yes, an Operating Agreement can be changed or amended as the needs of the business change. Typically, the Operating Agreement will specify a process for making amendments, which often requires a certain percentage of member voting approval.

Who gets a copy of the Operating Agreement? All members of the LLC should receive a copy of the Operating Agreement. Additionally, you might need to provide a copy to your bank for business accounts, to potential investors or lenders, or in the case of legal disputes involving your LLC. However, it is not usually submitted to any government entity, which helps maintain your business arrangements’ privacy.

Do single-member LLCs need an Operating Agreement? While it might seem unnecessary for a single-member LLC, having an Operating Agreement is still a good idea. This document can help maintain the LLC’s limited liability status by demonstrating that the business is a separate legal entity, and it can also provide a plan for what happens if the owner becomes incapacitated or dies.

How is an Operating Agreement different from Articles of Organization? Articles of Organization are the document that you file with the state to legally form your LLC, while the Operating Agreement is an internal document that outlines how the LLC will be run. Both are important, but they serve different purposes.

Does an Operating Agreement need to be filed with the state? Generally, no. The Operating Agreement is an internal document, meaning it’s for the members of the LLC and doesn’t need to be filed with the state. The document filed with the state is usually the Articles of Organization.

Can an Operating Agreement override state law? While an Operating Agreement can dictate many aspects of the LLC’s operations, it cannot override state law. For example, if a state has specific laws regarding LLC members’ rights, the Operating Agreement cannot take those rights away. Similarly, if a state requires certain records to be kept or meetings to be held, the Operating Agreement cannot negate those requirements.

Is a lawyer needed to create an Operating Agreement? While it’s possible to create an Operating Agreement on your own, especially with available templates online, it’s often recommended to seek legal advice. A lawyer can help ensure that the agreement is comprehensive and legally sound and meets your LLC’s specific needs.

How do you enforce an Operating Agreement? An Operating Agreement is a legally binding contract among the members of an LLC. If a member breaches the agreement, they can be taken to court and potentially held liable for damages. That being said, the exact enforcement process can vary depending on your state’s specific circumstances and laws.

Can a member be removed according to the Operating Agreement? Yes, most Operating Agreements will have provisions detailing how a member can be removed voluntarily (such as by selling their interest) or involuntarily. This process should be outlined clearly to avoid potential disputes.

What happens if an Operating Agreement is not followed? If the terms of an Operating Agreement are not followed, it can lead to disputes among the LLC members. In some cases, it might result in legal action. Not adhering to the agreement could also affect the LLC’s standing, possibly jeopardizing its limited liability status.

How often should an Operating Agreement be updated? There’s no set rule, but it’s a good idea to review the Operating Agreement regularly, such as annually, and update it as needed. For example, if a member leaves or joins the LLC, if the business significantly expands or changes its operations, or if the members decide to change how profits and losses are distributed, the Operating Agreement should be updated to reflect these changes. As outlined in the agreement itself, any amendments typically need to be agreed upon by a certain percentage of the members.

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