Operating Agreement

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Operating Agreement

A Brief Introduction about the Agreement

An operating agreement provides written evidence of the terms and conditions that the members of a company (limited liability company) agree to. The agreement takes into account every possible issue and contingency and highlights measures for it.

The agreement describes what actions should be taken should anything happen during day-to-day operations of the company and in case of a special event, for instance, if one of the owners dies or gets divorced. It also lists the duties of the owners and their responsibilities for the daily operations of the business.

While each operating agreement is unique, based on the individuals and their circumstances, it does help to have an operating agreement template at hand when drafting this agreement.

What is Operating Agreement?

If you are wondering what this agreement is about, you should know that while the states in the US do not mandate that businesses have an operating agreement in place, this business contract forms the only evidence of ownership percentage, the names of the owners and when the members will have their annual meeting.

The agreement is a legal document for the internal purpose and lists the rights and responsibilities of each owner, the decision-making process, the internal management process, and how new members will be admitted into the LLC.

Who Takes the Operating Agreement – People Involved

The operating agreement is signed between the members of an LLC who have made a capital contribution (like services, money, or property) to the company in exchange for an ownership stake in the company.

Purpose of the Operating Agreement – Why Do You Need It?

The purpose of the operating agreement is to protect the business and its members. It is prudent to realize that most states in the US do not require this agreement for an LLC, but not having one can leave the members at the mercy of the state laws should anything go wrong during the operation of the business. For instance, some states mandate that profits be equally shared between owners, but an operating agreement allows you to decide how to share the profits.

Even if you are the sole owner of an LLC, it is essential to have LLC Operating agreement in place. It helps you prove that your company is a limited liability company and not a sole proprietorship.

Contents of the Operating Agreement – Inclusions

Some of the key terms of the operating agreement are as follows:

  • Name of the LLC
  • The formation date of the company
  • Name and address of the registered agent
  • The purpose why the LLC was formed
  • Information of the members – their names and addresses
  • Contribution of each member as well as the type of contribution
  • Liability of each member
  • The process to admit new members
  • Management of the business – who is managing the operations? If it is a manager, the list of things that the manager can do
  • Fiduciary duties – the operating agreement should list the fiduciary duty of the members, officers, and managers, including contractual obligations, fair dealing and duty of good faith
  • Meetings – when will the members hold meetings
  • Dissolution and Termination – Circumstances leading to the dissolution of LLC or termination of members, manager and officer

How to Draft the Operating Agreement – Points to Consider While Preparing the Agreement

When drafting an operating agreement, keep the following in mind:

  • Involve all the owners and members when creating an operating agreement
  • Identify the company and the address
  • Mention the purpose of the business
  • Explain the duration the LLC will stay in existence
  • Ensure the key terms are clearly defined to minimize ambiguities and misunderstandings
  • State the ownership percentage of each member
  • Mention what will happen if a member withdraws their contribution
  • Highlight the procedure to induct new members
  • State how profit and losses will be distributed between members
  • Explain the voting rights of the members
  • Identify the member or manager who will oversee day-to-day operations
  • List down the member or manager’s responsibilities
  • Detail how the manager can resign or be removed from his/her position
  • Should include a sign and date of all the members in the agreement

Types of Operating Agreement

There are primarily two types of operating agreement. They are as follows:

  • Single Member: The LLC has just one owner and having such an agreement ensures the legal authorities know that it is an LLC and not a sole proprietorship. Hence, the owner will not be liable for debts and losses.
  • Multi-Member: Such an agreement is created when there are multiple owners, and the agreement highlights their ownership interest and distribution of profits.

Negotiation Strategy

There is not much room for negotiating an operating agreement. However, you can discuss with other members about your share of the ownership and distribution of profits. Usually, the profit distribution is proportionate to the contribution. You can point out the value you bring to the table and try and get a higher percentage of the profits. 

Benefits and Drawbacks of the Operating Agreement

Some of the advantages of an operating agreement are:

  • Helps to minimize disputes between members by clearly mentioning the voting rights and scope of duties and responsibilities
  • Ensures your LLC does not have to follow the state laws that govern LLC
  • Takes into consideration different aspects, including possible dissolution of the LLC should a member die or decide to leave

Some of the disadvantages of an operating agreement are:

  • It can be expensive to draft the agreement as it may require an attorney if you do not use an operating agreement template
  • Drafting the agreement can be time-consuming
  • The agreement lists the duties and power of the manager member, and it could be restrictive for the member

What Happens in Case of Violation?

The operating agreement usually mentions the jurisdiction that governs it and what happens if members violate the agreement. So, if a member violates the agreement, other members can draw on the provisions in the agreement to handle it internally and take remedial measures, including dissolution of the LLC.

In most agreements, there will be a clause that allows members to resolve issues without taking the matter to court. However, if the issue is too big to resolve internally, then other members may decide to take the offending member to court. This said, most agreements take into account possible violation and have provisions for managing it.

Whether you are a single owner or have multiple owners, an operating agreement offers the framework to handle the business and management aspects of your LLC. It helps to protect the interests of the members and ensures smooth operations. So, it is essential to have such an agreement in place. You can easily download an operating agreement sample from here and customize it to suit your business needs and state laws.

Sample Operating Agreement

Download Operating Agreement Template

Operating Agreement

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