What is an operating agreement?

An operating agreement is an LLC document that outlines the business' financial and operating decisions through regulations and rules. The purpose of the document is to govern the operations of the business in order to best meet the specific needs of the business owner. Once the document is signed by the members of the limited liability company, it is an officially binding contract that the LLC must operate by.

Purpose of an operating agreement:

Operating agreements serve a variety of uses within a normal business structure. The most formal use of an operating agreement is to ensure that the business stays classified as an LLC and not as a partnership/sole proprietorship, which could negatively impact the limited liability offered by this structure.

Operating agreements also serve as a way to get business agreements in legally binding writing that can be referred to if any issues arise. Verbal agreements are insufficient for this serious type of business structure, and having an operating agreement offers a mutually agreed-upon way to settle disputes within the operation of the LLC.

The addition of an operating agreement also helps to limit the state’s involvement in how you run your business. If an LLC does not have a written operating agreement, state default rules often apply, which are likely not ideal for effectively managing your business decisions and disputes.

By writing up this agreement for an LLC, a business ensures that it will consistently and professionally operate on the ideal terms for that business’ success.

What’s included in an operating agreement?

The following are common inclusions in an operating agreement for an LLC:

  • Distribution of profits and losses
  • Responsibilities of members
  • Voting rights
  • Ownership distributions
  • Details of holding meetings
  • Buyout rules
  • Dissolution

Many LLC operating agreements will focus on the critical topics in order to ensure complete clarity for all members as well as legally enforceable regulations, while only briefly covering other operational decisions.

Conclusion:

It is highly recommended that all LLCs create an operating agreement for their members in order to streamline management, avoid legal grey areas, and maintain complete decision making control of their business. Even in states that do not require an operating agreement for LLCs, an operating agreement should be created that covers at a minimum the basics of how the LLC will be run.