What is an Operating Agreement: An operating agreement is one of the most important (though not always mandatory) legal documents you require to establish a business (especially an LLC). Several legal agreements and licenses must be created whenever a new Limited Liability Company is set up. These documents ensure that your LLC has been registered properly under the state government and that the business has met all the legal and judicial terms. An Operating Agreement is one such legal document that LLCs need to have. So here is all about an LLC operating agreement.
On this page, you’ll learn about the following:
- What is an LLC Operating Agreement?
- What an Operating Agreement Should Contain
- Why Do I Need an Operating Agreement?
- What to Do After Completing the Operating Agreement?
What is an LLC Operating Agreement?
An operating agreement is a legal record that has all the details of the LLC and its members. Generally, the operating agreement has information from the formation to the dissolution of an LLC. Besides, this document structures the financial functionality of the LLC. Some states may not have the mandatory rule to have an Operating Agreement, but it is necessary to have such a document when you run your business.
Amongst all the documents that have to be drawn out is the Operating Agreement, which should be taken care of right after you register the business name and choose the registered LLC agent. The Operating Agreements consist of various clauses and other detailed points describing the business in depth. These documents will also explain the relationships between the members and the managers appointed in the business.
How Does an Operating Agreement Work?
As mentioned, an operating agreement is a document that records everything about an LLC from top to toe. This document must be filed just after you register your LLC with the state. As the agreement has all the financial and structural functionality of the LLC, it certainly protects the LLC and its members when needed.
As said earlier, some states do not have any legal rules for filing the operating agreement. In that case, the LLCs have to follow the rules set by the State. For example, LLCs must follow this rule if the State requires equal profit division among the members, irrespective of the capital share. An Operating Agreement makes things easier, more transparent, and clear.
What an Operating Agreement Should Contain
The exact content of the Operating Agreement will be decided by the business members only. However, every agreement should have six different sections, which will indicate all the functional and managerial aspects of the LLC business. For better convenience, you can hire a professional who provides an Operating Agreement template to understand it better. You can explore the best LLC service to choose the best one in the market. Rest assured, and your company agreement should have the following six departments at any cost.
Article I: Organization
The first article will talk about your LLC business itself. This section will contain all the basic information units that form the overall skeletal of the company. For starters, the date of formation and the founder information should be mentioned in this Article section. Following this, the list of the member names should be there, the percentage of ownership for a multiple-member LLC and other such details.
Article II: Management and Voting
Article II talks about Management and Voting. Everything related to company management and voting procedures is discussed in this Article. The following points are mentioned clearly in this section:
- Who will manage the business – the LLC can be managed by one or more members or by managers that members appointed. The authority overseeing the company’s affairs will be mentioned clearly to avoid future conflicts of interest.
- How the voting should be carried out – Everything related to the voting will be discussed, like the number of votes per member or unit percentage of ownership and how many votes will be required to bring the reform into motion within the company.
Article III: Capital Contributions
In this Article, you talk about capital contribution by the members/managers of the LLC. The initial capital investment, amount of capital deposited, contribution of members and managers to the capital deposit, and all other details about capital investment must be mentioned in this Article. Besides, this Article also covers future revenue share among the members and managers. Also, this section talks about future company growth.
Article IV: Distributions
This section discusses the distribution. Article IV records the percentage of ownership that will affect the shares, profits, and asset distribution for any multi-member LLC. This article will discuss how much profit will be distributed among all members and in what ratio the business assets must be divided. Any other distribution-related points should be covered in this Article.
Article V: Membership Changes
In this section, everything related to the membership will be discussed. Clauses related to the addition, removal, or transference of a member or two must be mentioned in this section. Apart from this, the terms and requirements for the membership changes will also be mentioned so that no conflict can arise in the future.
Article VI: Dissolution
The last section remaining the same in all the Operating Agreements, is about the dissolution. If the LLC has to be dissolved in the near future, this section will state the circumstances under which the dissolution decision needs to be taken, the prerequisites for the dissolution, and others. Article VI is said to be the “winding up” part of the document, where the end course of the LLC is specified in case the company fails to achieve its goals.
Other Topics Discussed in the Agreement
Apart from the points to be discussed in the six articles of all the Operating Management, some other topics can also be included which will discuss the requirements of the business, including the meeting schedules, the annual reports, and so on.
Why Do I Need an Operating Agreement?
Not all states require the business owner to provide an official Operating Agreement. Rather, only in Missouri, California, Maine, Delaware, New York, and Nebraska must the LLC must provide the agreement when registering the company. Filing the operating agreement is not mandatory for the rest of the state. However, it is recommended to file the operating agreement for several reasons.
However, some reasons back up this mandatory need, which every LLC owner must know.
- The Operating Agreement covers details about how the company will work in the future, the interactions between the members and the managers, and other facts.
- The default rules and other statements are mentioned in the custom Operating Agreement that will be drawn before the registration of the LLC.
- Every single detail about the capital contribution, the members involved in the contribution, and the management process of future investments will be mentioned in the agreement.
- The Operating Agreement outlines the dissolution rules, membership change rules, and other minute details and principles on which the LLC structure is formed.
What to Do After Completing the Operating Agreement?
Once the LLC Operating Agreement is set up, you must follow the rest of the processes required for successfully setting up the business and running it in the concerned state. You can hire professional consultants who will guide you in the LLC formation process once the agreement is set up and filed.
Steps to Take After Filing an Operating Agreement
Time needed: 5 minutes
- Get the EIN
You must get the EIN number once the agreement’s filing is successful. This unique nine-digit number will allow all the LLC businesses to make proper transactions, hire employees, and pay income taxes, pension taxes, and other functions. The EIN number filing needs to be done with the IRS department of the concerned state.
- Open a Business Bank Account.
Your business will need the bank accounts from which you and other members can make all the transactions, be it transference of money, processing the payrolls of the employees, taking a loan for the business, and so on. You must submit the Operating Agreement, the name registration certificate, the EIN number, and a nominal fee for opening the business bank accounts.
- Register the LLC for State Taxes
After this, you must register your LLC business with the IRS to understand more about the tax requirements. If your LLC is involved in hiring employees, you need to register for the unemployment pension tax. Meanwhile, if the LLC depends on selling services, you must look further into the sales taxes and income tax registration process.
- Get All the Needed Licenses and Permits.
You need to get all the licenses and permits related to the LLC business so that you can easily avoid legal and judicial conflicts later on. Also, with the licenses in the right place, you can avoid legal lawsuits filed by someone else.
- Have the business insurance ready
You also need to ensure that the liability insurance papers are ready to be filed by the time you finish the previous steps. This type of insurance will prevent your company from falling to the depths of bankruptcy, losses, and others.
How to Write an Operating Agreement
An operating agreement includes all the details of the members of an LLC, their roles and responsibilities, terms of leaving as well as dissolution of the business.
Before diving into the specifics, it is important to understand the core purpose of an operating agreement. Simply put, it is a contract between the members (owners) of an LLC that provides an agreed-upon set of rules for how the company will be operated. While not all states legally require an LLC to have an operating agreement, creating one is highly advisable as it offers several benefits, including protection of limited liability status, adding credibility, and preserving the internal structure. It provides an opportunity to iron out important details, address potential disputes, and maintain flexibility.
When starting the drafting process, the first step is to examine the needs and goals of the LLC. The operating agreement should reflect the unique circumstances and preferences of the company while adhering to relevant laws and regulations that govern LLCs in the respective jurisdiction. To ensure that it encompasses all necessary aspects, several key sections should be included:
1. Ownership and management: Identify the members and define their ownership interests, clearly outlining the relative rights and responsibilities. Additionally, establish how the LLC will be managed, whether by the members themselves (member-managed) or by appointed managers (manager-managed).
2. Decision-making processes: Define how decisions will be made within the LLC. This may include stipulations on voting rights, procedures for major decisions, and how to handle deadlocks if they arise. Articulate how meetings will be conducted, agenda items, and the quorum required.
3. Distribution of profits and losses: Outline each member’s share in profits and losses, which may or may not be proportional to their ownership percentage. Specify the frequency and method of distributing profits and allocating losses.
4. Transfer of membership interests: Establish guidelines regarding the selling, gifting, or transferring of membership interests to third parties or fellow members. Outline any conditions or restrictions that members must fulfill before such transactions can take place.
5. Dissolution and dispute resolution: Detail the process for dissolving the LLC or resolving disputes among members. Define the circumstances that trigger dissolution, mechanisms for mediation or arbitration, and procedures for winding up the company’s affairs.
While drafting an operating agreement can be a complex undertaking, it is not an unfathomable task. Consulting with an attorney versed in LLC formation can prove invaluable and help navigate the legal complexities, but even without professional assistance, diligent research and attention to detail can yield a solid agreement.
In conclusion, a well-written operating agreement is crucial for the smooth functioning of an LLC. It establishes the foundation for governance, minimizes disputes, and maximizes the limited liability protection that LLCs afford. By carefully considering the unique needs of the business, addressing key sections, and ensuring compliance with relevant laws, LLC owners can create a comprehensive operating agreement that safeguards their interests and preserves the internal cohesion of the company.
The cost of the Operating Agreement will depend on the state from where you will be filing the document. But you can get an approximate amount by using the operating agreement tool.
Bylaw and Operating Agreement are the same since both documents describe everything about internal operations. However, the Bylaws are drafted for a corporation, whereas the Operating Agreement describes the LLC.
Without the agreement, the LLC company will create roadblocks between the management, ownership, and accounting pillars. Not all the members will agree at one point without the agreement. Also, you couldn’t file for the EIN, so your corporate veil will dwindle.
An operating Agreement is not always mandatory to file, except in a few states. It is an internal document that records all the in-and-out of the business (LLC). If you choose any LLC formation service to establish your business, you must check if they provide an operating agreement draft. Most top-rated services offer operating agreement drafting, including other formation services.
While writing the operating agreement, one must ensure to properly mention the six above-mentioned Articles to avoid any discrepancy in the future among members of the LLC. You can also consult a corporate attorney to write this agreement on behalf of your LLC.