What is an Operating Agreement?
Limited Liability Companies (LLC) use operating agreements to lay out how the LLC will be operated and how disputes will be resolved. It is a binding contract between the owners of the LLC (a.k.a. "members") when the business is formed and can be specifically tailored and amended to the changing needs of the LLCs and its owner(s).
Do I Need An Operating Agreement for My Business?
It depends on the state in which the entity was formed. If you are not required to have an operating agreement, your LLC will be governed by the state's default LLC rules which are governed by local law.
But you should have an operating agreement for a host of reasons whether you are a single member LLC or if your LLC is owned by multiple members. Here are a few:
- The state's default rules regarding LLC operations are very general and may not be optimal for the management of your specific business.
- An operating agreement helps protect the LLC owners from being personally liable for the debts of the LLC-the main reason why you create a separate legal entity in the first place.
- An operating agreement provides a clear set of rules for how each of the owners should behave. Having these rules written down and in one document makes it less likely that verbal agreements will be misconstrued over time if a dispute arises between the LLC's owners.
- Finally, the operating agreement can outline how future disputes will be resolved (albeit through good faith negotiations, mediation, arbitration, and/or litigation). If dispute resolution is structured properly in an operating agreement, it could decrease the possibility of a messy business divorce.
What Does an Operating Agreement Include?
Most operating agreements will cover the following topics
- The LLC's registered agent/registered address
- Whether the LLC is managed by a manager ("manager managed") or by all of its members ("member managed")
- Ownership percentages
- How and when meetings are held
- Voting rights and responsibilities
- Powers and duties of members and managers
- Capital contributions
- Distribution of profits and loses
- Accounting Practices
- How and where the LLC's books and records are maintained
- Process for transferring interests or in the event of a death
- How to determine the fair market value of the LLC
- How and when the LLC may be dissolved
- Mechanisms for resolving disputes
Should I Hire a Lawyer to Draft an Operating Agreement?
Given how critically important an operating agreement is to the success of the LLC, it is not recommended to draft your own operating agreement. And in some states an operating agreement is required. Even if an operating agreement is not required by state law, there are a host of accounting issues that must be addressed with an accountant before an operating agreement is negotiated.
As a result, you should consult with a business lawyer so the needs of your specific business are covered in your LLCs operating agreement. Doing so may also help you avoid a potential business divorce and other future disputes.