What Is an Operations Agreement?
An operations agreement (or operating agreement) is a document used by a limited liability company (LLC) to lay down rules and regulations governing the business. It can be compared to a corporation’s bylaws and is used to regulate an LLC’s internal business operations. It contains all the conditions agreed to by members of the company. This agreement takes financial and functional decisions in an LLC. Once the members of the LLC sign it, it becomes a binding contract between them.
Most states in the United States of America do not mandate this agreement. In such cases, the respective state’s law (default rules) governs the agreement.
When Do You Need an Operations Agreement
It is required for the smooth functioning of the LLC. It envisages all possible situations and how to manage them, thereby protecting the business from uncertain situations. It avoids disputes among members as the terms are put down in writing and can be referred in case of conflicts. It allows them to establish a business structure according to their understanding. The members can prescribe limits to their liability, thereby shielding themselves from personal liability.
In the absence of a formal operations agreement, the state’s default rules apply, which are very general and may not suit a particular type of business. For example, the default rules may prescribe equal ownership for each member, but you may want to vest ownership in proportion to the capital investment made by the members. Having a formal agreement in place allows for such freedom in running the business.
Key Terms of an Operations Agreement
The following key terms should be included in the agreement :
- Name and address of the registered office of the LLC. Also, mention if it is transacting business under any other name.
- A certificate of formation of the LLC.
- Purpose of the LLC
- Term of the LLC- Usually, an LLC continues until terminated.
- Definitions of the terms used in the agreement
- Names and addresses of the members
- Contributions of the members
- Percentage of members’ ownership
- Allocation of profits/loss
- Duties and responsibilities of members
- Meetings of members
- Voting rights of members
- Introduction of new members
- Withdrawal and expulsion of members
- Transfer of an interest in case of death of a member
- Dissolution of LLC
- Records of the LLC
- Governing law of the agreement
- Signatures of all the members
Drafting an Operations Agreement
While it is not compulsory to have this agreement in most states, a company should draft one for itself. All the members should come together and discuss the key terms of the business. These can then be incorporated into the agreement. The following points are worth noting-
- The members should agree on the rules stating how the business will be run. If they run the business, then the duties of each of them should be written in the agreement. Clauses should be incorporated to deal with situations if a member is not able to perform up to the mark.
- In case they agree to have a manager take care of business operations, they can get involved in policy-making decisions, the substance, and the procedure of which should be clearly elucidated in the contract.
- An important point to clarify in the agreement is the percentage of ownership of each member. Ownership is in proportion to the capital invested by each member. It gives him the right to receive profits/losses of the company. How the profits and losses will be allocated and distributed should be made clear.
- Members should be made aware of their voting rights. The provision should take care of situations that result in an equal number of votes, and a tiebreaker is required.
- Ensure that the duties of each member are specified so that there is no confusion.
- A clause providing for any amendment to the agreement should be included. It should prescribe the process of carrying out an amendment.
The members of the LLC can draft the agreement by themselves. However, it is important to get it reviewed by a lawyer to avoid any misconception.
Types of Operations Agreement
These are of different types-
- Single-member operating agreement: Used by a single member who is the owner of the LLC
- Multi-member: Used by an LLC has more than one member.
- Member-managed: In such a multi-member LLC, all members are permitted to manage the daily activities of the business.
- Manager- managed: In Manager- managed LLC, a manager or management committee runs the day-to-day affairs of the business.
[ Also Read: Limited Liability Partnership Agreement]
What Happens in case of Violation?
If this agreement is violated or needs to be interpreted by a court, then a member of the LLC can file a suit in the local court of the state whose law governs the agreement.
An operations agreement is a complex legal document. When drafting it, it is important to check with the state’s business division about applicable laws and regulations. The language of the agreement must meet the requirements of the specific state. Its clauses must comply with these laws and requirements. Otherwise, the agreement will not be valid.
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Sample Operations Agreement
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