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What is an operating agreement and why should your business have one?

| Jan 24, 2021 | Firm News

What is an operating agreement?

An operating agreement, also known as a buy-sell agreement, is a document that tailors the terms of a limited liability company (LLC) to meet the specific needs of its owners. The agreement thus clarifies the internal operations of the LLC according to its members. It also outlines the financial and functional procedures of the business as well as what happens if one member wants to sell their interest to someone else.

Why do you need an operating agreement?

Although an operating agreement is not required for most states, it is nonetheless a vital document that should be drafted when forming an LLC. The agreement, once signed by each member, acts an official contract binding the members to its terms. Thus, the document, also known as a Buy/Sell agreement, is drafted to allow owners the ability to govern the internal operations according to their own specifications. In the absence of an operating agreement, your business has to be run according to the default rules of your state. Oftentimes, default rules encompass broad and general provisions that might fail to reflect the structure and operation of your business. For instance, in the absence of an agreement, your state may require all profits in an LLC be shared equally by each partner regardless of each party’s ownership percentage or capital contributions.

Having an operating agreement can also provide additional benefits. If you are the sole member of an LLC, creating an operating agreement establishes credibility and protects the business’ limited liability status thereby providing protection from personal liability. If you have a multi-member LLC, an operating agreement can provide clarity and prevent misunderstandings by detailing clear expectations about members’ roles and responsibilities. Furthermore, the agreement solidifies any existing verbal agreements.

What is included in an operating agreement?

A standard operating agreement outlines the internal operations of the LLC and often includes, but is not limited to, the following main provisions:

  • Organization
    • The name of the LLC
    • When the company was created
    • Information about the Articles of Organization
    • Purpose of the business
    • Who the members are
    • Structure of Ownership
  • Member’s Ownership Interest
    • Percentage of member’s ownership
  • Management and Voting
    • How the company is managed
    • Powers and duties of members and managers
    • Rules related to holding meetings
    • Voting rights and responsibilities
  • Capital Contributions and Distributions
    • Members’ contributions
    • Distribution of profits and losses
  • Transfer of Ownership
    • The process of adding and/or removing members
    • Buyout and buy-sell rules
    • Procedures for transferring interest or in the event of a death or divorce
  • Dissolution
    • The circumstances in which the company may be or must be dissolved
    • Known as “winding up” the affairs of the business

If you have questions about how to create an Operating Agreement for your business, please contact Windrose Law Center PLC at 602-457-1846 or click here.

-By: Dylan Wilson, Law Clerk, Windrose Law Center PLC

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