Operating Agreement

An Operating Agreement is an internal, foundational legal document used by a Limited Liability Company (LLC). It acts as the official rulebook for the business, clearly defining how the company will be run, how financial decisions will be made, and who owns what percentage of the company.

Unlike Articles of Organization, an Operating Agreement is generally not filed with the state government. It is kept internally alongside your other vital business records.

Is an Operating Agreement Required?

Most states do not legally require you to have a written Operating Agreement to form an LLC. However, operating without one is highly discouraged for several critical reasons:

1. Protecting Your Liability Shield: The primary reason you form an LLC is to separate your personal assets from your business liabilities. A formal Operating Agreement proves to courts that your LLC is a legitimate, separate legal entity rather than just an alter-ego for your personal finances.
2. Overriding State Default Rules: If you do not have your own agreement, your LLC is automatically governed by your state’s default LLC laws. These default laws might dictate how profits are split or how a member’s departure is handled in a way that goes against your actual wishes.
3. Opening Bank Accounts: Nearly all banks require you to present an Operating Agreement to open a business checking account or secure a business loan, even if the state does not require the document.

What Does an Operating Agreement Include?

A comprehensive Operating Agreement is tailored to the specific needs of the business, but a standard document typically covers:

• Ownership Percentages: The exact percentage of the company owned by each member.
• Voting Rights: How major decisions are made and how much voting power each member holds.
• Profit and Loss Distribution: Exactly how and when the business’s profits will be distributed to the owners.
• Management Structure: Whether the LLC is run by the members themselves or by appointed managers.
• Changes in Membership: The rules for adding new members, or what happens if a current member wants to leave, becomes incapacitated, or passes away (often called buyout or buy-sell provisions).
• Dissolution Rules: The specific steps required to formally close and dissolve the business.

Single-Member LLCs

If you are the only owner of your business (a Single-Member LLC), you might assume you do not need an Operating Agreement because you cannot have a dispute with yourself. This is a dangerous misconception. A Single-Member Operating Agreement is arguably the most important document you have to prove to a judge that you and your business are separate entities, thereby protecting your personal savings from business lawsuits.