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The Role of Operating Agreements in LLC Management

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When you start a Limited Liability Company (LLC), you take a big step toward realizing your business dreams. An LLC is a famous business structure for many reasons, mainly because it offers protection from personal liability in many situations. But forming an LLC isn’t just about filing paperwork with your state; it’s also about how you manage and run it day-to-day. The operating agreement is one of the essential tools for effectively managing your LLC.

What is an Operating Agreement?

An operating agreement is a document that outlines your LLC’s ownership and member duties. Think of it as a rulebook for how your LLC operates. Although not all states require an operating agreement, having one is highly recommended because it ensures that all business owners are on the same page and reduces the potential for conflict.

Why Is an Operating Agreement Important?

  • Clarifies Verbal Agreements
Verbal agreements are easy to remember and interpret. Having everything in writing helps prevent misunderstandings about financial arrangements and responsibilities. Example: Suppose two members of an LLC, Alice, and Bob, verbally agreed that Alice would contribute more financially at the startup phase while Bob would handle day-to-day operations. They also decided that profits would be split 60/40 in Alice’s favor to compensate for her larger initial investment. However, without this agreement in writing in an operating agreement, Bob might later claim that he was entitled to a 50/50 split of the profits, leading to disputes and potential legal battles. An operating agreement that documents their arrangements and financial agreements prevents such misunderstandings and provides a reference point should any disputes arise.  
  • Protects Your LLC’s Status
With an operating agreement, your LLC might look more like a sole proprietorship or partnership, which can jeopardize your limited liability status. An operating agreement helps reinforce your business’s legitimacy as a separate legal entity. Example: Imagine a scenario where an LLC formed by a group of members is sued. With an operating agreement specifying the business structure and member roles, a court might see much difference between the members’ and LLC operations. This might lead to a “piercing of the corporate veil,” where members’ assets could be targeted to settle business liabilities. An operating agreement helps maintain that essential separation, clearly defining the LLC as a distinct entity with its governance and operational procedures, thereby protecting members’ assets.  
  • Prepare for the Unexpected
If a member wants to leave the LLC or the business goes through a rough patch, the operating agreement sets clear protocols for handling such situations without significant disruptions. Example: Sarah and John are members of an LLC. John decides to leave the LLC to pursue other interests. Their operating agreement includes a clause on how a member can exit, detailing the buyout process, valuation of the departing member’s shares, and how the remaining members can purchase those shares. This clause ensures that John’s departure is handled smoothly without financial or operational disruption to the business. Without such provisions, his exit could lead to uncertainty, financial disputes, or even a forced dissolution of the LLC if no agreement can be reached.  
  • Customizes Your Rules
An operating agreement allows you to set up rules for running your LLC instead of defaulting to generic state rules. You can decide how profits are split, decisions are made, and other essential management details. Example: A three-member LLC decides that significant decisions, like acquiring another company or making substantial investments, require a unanimous vote, while everyday decisions only need a simple majority. They also agree to distribute profits according to each member’s operational involvement rather than equally. This arrangement is documented in their operating agreement. By customizing these rules, the LLC operates to fit the members’ unique situations and business goals, which could significantly differ from the state’s default rules that might otherwise apply. Having these specifics documented in an operating agreement allows LLC members to ensure that their business operates under clear, agreed-upon rules that suit their specific needs and protect their interests. This helps in day-to-day management and secures the business’s future, facilitates growth, and minimizes conflicts, making the LLC’s operation smoother and more efficient.  

Critical Components of an Operating Agreement

While operating agreements will vary from business to business, certain essential elements should be included:
  • Ownership Structure: Details each member’s ownership percentage.
  • Voting Rights and Responsibilities: This section specifies who can vote, how the votes are calculated, and what decisions require voting.
  • Distribution of Profits and Losses: How and when will profits and losses be distributed to members?
  • Management Structure: Whether the LLC is member-managed or manager-managed.
  • Rules for Meetings and Voting: Frequency of meetings and the process for voting.
  • Buyout and Buy-Sell Rules: Procedures for when a member wants to sell their interest, dies, or becomes incapacitated.
 

Professional Services for Drafting Operating Agreements

Creating an operating agreement might seem daunting, but there are professional services that can help simplify the process. Here are three highly recommended services:

9.8

4.7/5
Our top pick for reliability and affordability – over 3 million businesses served

9.6

4.4/5
Comprehensive LLC business formation services all in one place.

9.4

4.8/5
A go-to service for all business owners looking to start an LLC, S Corp, or C Corp

Northwest Registered Agent

Services Offered:
  • Expert advice and custom drafting of operating agreements tailored to your specific needs.
  • LLC formation services with a focus on personal privacy.
Benefits:
  • Northwest Registered Agents’ expertise ensures that your operating agreement covers all legal bases and meets state-specific requirements.
  • They also offer registered agent services, which can help maintain your LLC’s compliance with state law.
 

Swyft Filings

Services Offered:
  • Standard operating agreement templates that can be customized for your LLC.
  • Full-service LLC formation and compliance support.
Benefits:
  • Swyft Filings provides a quick and efficient service, making it easy to get your operating agreement and other LLC paperwork in order.
  • They also offer various business services bundled with your LLC formation.
 

Bizee

Services Offered:
  • Tailored operating agreement drafting, especially for small businesses and startups.
  • Business formation and legal documentation services.
Benefits:
  • Bizee focuses on providing personalized services, ensuring that your operating agreement fits the unique aspects of your business.
  • Their platform also helps new business owners navigate the complex legal landscape of starting and running an LLC.
 

How to Use Your Operating Agreement

Once your operating agreement is drafted, here’s how to use it effectively:
  • Member Access: Ensure all members have a copy and understand the contents.
  • Review Regularly: As your business evolves, so might your management needs. Review and update your operating agreement as needed.
  • Enforce the Rules: Adhere to the protocols established in the agreement to avoid conflicts and ensure smooth operation.
 

Conclusion

The operating agreement is more than just a document—it’s a foundational tool that guides your LLC’s internal operations. It helps you manage your business more effectively, prepare for future changes, and maintain good standing with the state. Professional services like  Northwest Registered Agent, Swiftfilings, and Bizee can provide expert guidance and peace of mind that your LLC is set up for success. Remember, a well-crafted operating agreement can save you time, money, and hassle in the long run.

FAQs: The Role of Operating Agreement in LLC Management

  • Is an operating agreement required in all states?

    Not all states require LLCs to have an operating agreement, but it is mandatory in some states, like New York, California, Missouri, and Delaware. Even if not legally required, having an operating agreement is highly recommended as it provides clear rules and expectations and helps protect the LLC’s limited liability status.

  • Can an operating agreement be modified once it is created?

    Yes, an operating agreement can be modified if changes are needed. However, modifications typically require the approval of a certain percentage of the LLC members, as specified in the contract. To avoid future disputes, it’s important to document any amendments properly and ensure all members agree to the changes.

  • What happens if an LLC does not have an operating agreement?

    Without an operating agreement, an LLC is subject to the default rules imposed by the state. These default statutes may only suit some businesses and can lead to misunderstandings or conflicts among members. An operating agreement allows LLC members to establish rules tailored to their specific needs.

  • How detailed should an operating agreement be?

    The details in an operating agreement can vary depending on the size and complexity of the business. Generally, it should cover all essential aspects of business operation, including financial management, member duties and responsibilities, dispute resolution methods, and procedures for joining or leaving the company: the more comprehensive the agreement, the less ambiguity and potential for conflict.

  • Do single-member LLCs need an operating agreement?

    While single-member LLCs are less likely to have disputes between members, having an operating agreement is still beneficial. It can reinforce the legal distinction between the owner and the business, crucial for maintaining limited liability protection. Furthermore, an operating agreement can provide a structured plan for growth and business succession.

  • Should an operating agreement be filed with the state?

    An operating agreement does not need to be filed with the state. It is an internal document meant to guide the operations of the LLC. However, it should be kept on record with other essential business documents and be readily available for reference or if required by legal or financial institutions.

  • How does an operating agreement influence financial decisions within an LLC?

    An operating agreement often outlines how financial decisions are made, including allocation of profits and losses, handling of business expenses, and criteria for economic investments. This can help ensure financial operations are handled consistently and transparently, reducing the potential for economic mismanagement.

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