If you are seeking a business structure with more personal protection but less formality, then forming an LLC, or limited liability company, is a good consideration. Regardless of your business structure, some paperwork like an operating agreement is expected. Here are the basics every LLC owner should know about operating agreements:
What is an operating agreement?
An operating agreement is a key document used by LLCs 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 business in a way that suits the specific needs of the business owners. Once the document 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.
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.
Side Note: 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
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 in which it was formed. Many states do not require operating agreements. This information can generally be found on your Secretary of State website.
Side Note: 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.
Where should operating agreements be kept?
Operating agreements should be kept with the core records of your business. They are not required to be filed, nor will they be accepted by your state.