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.
If a company is a multi-member LLC, the operating agreement becomes a binding contract between the different members. This document serves as their pre-nuptial agreement. When business partners create this agreement at the start of the business, they go into the business with specific expectations that were laid out in the agreement.
In addition to clarifying ownership and structure, the operating agreement can also name the registered agent, give details like when meetings are held, select managers, and explain how the business can add or drop members. Simply put, the operating agreement outlines a business’s functional and financial decisions. Once the members of the LLC sign it, they are officially bound to its terms.
Most operating agreements contain six key sections, including:
- Organization – what is the name of your organization? What type of entity is it – LLC, S-Corp? The name, legal entity, and the official address of the business should be listed.
- Management and voting – who are the managers of the company and what role does each person play? Roles can be a Chief Executive Officer, President, Chief Operating Officer, Manager, Vice President, etc. The roles should be clearly defined as to responsibilities. Members get one vote per person.
- Capital contributions of members – how much money each partner contributes, and what percentage of the company do they own. For example, will each member have one vote, or will each member have voting power that corresponds to their ownership percentage? if each member puts in 50%, they own 50% of the company. However, members might choose to give one member a larger portion even if the amount of money contributed is the same. If there is a benefit to having a women-owned or minority-owned organization, a woman or minority needs to have 51% for the company to qualify.
- Membership changes – when can you add or delete members from the organization.
- Distributions – how and when are profits and losses distributed each year. You can set a specific percentage that will be distributed and a set percent will be put back into the business.
- Dissolution or Transition in Ownership – what are the causes to dissolve the company, what does each person get? What happens if one of the members die, has a long-term illness and must leave the company, or can no longer act in the original capacity? Can a member sell their shares without consent or must they give the current members the first choice of purchase?
According to Contractcounsel.com, there are several reasons why you need an operating agreement, including:
- Clarifies verbal agreements: The LLC operating agreement puts all agreements between the managing members in writing, so there are no misunderstandings. Members can then refer back to the operating agreement in the event of conflicts in the future.
- Protects members from personal liability: The operating agreement is a formality that protects the managing members from being personally liable.
- Ensures you aren’t subject to default state rules: When a business doesn’t have an operating agreement in place, the default rules set by the state will apply. For example, states have default rules that require the company to divide profits and losses equally. To avoid having to rely on your state’s basic operating rules, you should have an operating agreement in place.
If there are current spouses or one of the partners plans to get married in the future, a prenuptial agreement is a way to protect a family business, its income, resources, and assets. For example, the agreement can be used to prevent a non-owner spouse from accessing the business finances, acquiring a portion of the entity, and obtaining a support award based on the income generated by the business.
Have a lawyer work with you to create these documents as they have long-lasting ramifications. There are some standard templates that are sold online; however, it might not have all that you need to accommodate you. Just like you would get insurance to protect your assets, a business agreement is a pre-nup for your partnership. It will save you a lot of headaches and hard feelings in the future.