Do you have an Operating Agreement for your LLC?
If you are seeking a business structure with more personal protection but less formality, then forming an LLC, or limited liability company, is a very good flexible and affordable consideration. Regardless of your business structure, some paperwork like an operating agreement is expected and in some states required. Here are the basics every LLC owner should know about operating agreements:
What is an operating agreement?
An operating agreement is a key legal document used by LLC’s because it outlines the business’ financial and functional decisions including rules, regulations and provisions. The purpose of the document is to govern the internal operations of the LLC in a way that suits the specific needs of the business owners who are called members. Once the operating agreement is signed by the members of the limited liability company, it acts as an official contract binding them to its terms.
Why do you need an operating agreement?
- To protect the business’ limited liability status: Operating agreements give members protection from personal liability to the LLC. Without this specific formality, your LLC can closely resemble a sole proprietorship or partnership, jeopardizing your personal liability through a piecing of the corporate veil.
- To clarify verbal agreements: Even if members have orally agreed to certain terms, misunderstanding or miscommunication can take place. It is always best to have the operational conditions and other business arrangements handled in writing so they can be referred to in the event of any conflict.
- To protect your agreement in the eyes of your state: State default rules govern LLCs without an official operating agreement. This means that each state outlines default rules that apply to businesses that do not sign operating agreements. Because the state default rules are so general, it is not advisable to rely on a governing body state to manage your agreement.
- To help with financing from lenders.
Tip: Consult with an attorney and accountant to assist with the financial and legal matters of your agreement.
What does an operating agreement entail?
Operating agreements are contract documents that are generally between five and twenty pages long.
What is included in an operating agreement?
The functionality of internal affairs is outlined in the operating agreement including but not limited to:
- Percentage of members’ ownership,
- Voting rights and responsibilities,
- Powers and duties of members and managers,
- Distribution of profits and loses,
- Holding meetings, and
- Buyout and buy-sell rules (procedures for transferring interest or in the event of a death).
Are LLCs required to form an operating agreement?
The requirement of an operating agreement depends on the state it was formed in.
Tip: It is unwise to operate without an operating agreement even though most states do not require a written document. Regardless of your state’s law, think twice before opting out of this provision.
If you are thinking of stating a new business make sure you understand the legalities of the business entity that you choose. An LLC is a very flexible and affordable legal business structure and should have an operating agreement governing it.