Forming an LLC, or limited liability company, can be a very attractive option if you’re looking for a business structure with increased personal protection and fewer formalities.
Keep in mind that LLCs do require some additional paperwork, including an operating agreement.
by JamieD, Former SBA.gov Moderator
Here are the basics every LLC owner should know about operating agreements:
What is an operating agreement?
An operating agreement is one of the most important documents used by LLCs, because it structures the business‘ financial and functional decisions. 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, 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 that formality, your LLC can look too much like a sole proprietorship or partnership, jeopardizing your personal liability.
To clarify verbal agreements: Even if members have orally agreed to certain terms, misunderstandings can still arise. It is always best to have the operational conditions of your business 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 good idea to rely on them for your agreement.
What does an operating agreement look like?
Operating agreements are contract documents that are generally between 5 and 20 pages long.
The functionality of internal operations are outlined in the operating agreement including:
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 when members chose 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 it was formed in. While many states do not require operating agreements, some, such as Missouri and New York, do. This information can generally be found on your secretary of state website.
Tip: 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. In fact, operating agreements should be kept confidential.