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What is an Operating Agreement?

Updated: May 7

What is an Operating Agreement?

With so many different types of business documents, it's difficult to know what your business needs to have versus what's optional. As an experienced business attorney, I'm here to let you know what's most valuable for your business to have.

Learn more about what an operating agreement is and why it's important for your business to have one.

What is an Operating Agreement?

An operating agreement is a legal document that outlines the operations of an LLC and establishes the agreements between the members of the business. Essentially, it puts on paper what is expected of each member and clarifies what will happen under various situations or when there is an operational dispute between the members.

What Should an Operating Agreement Include?

While the contents of your operating agreement are entirely up to you as the business owner, there are a few common sections that all operating agreements should include.

What Happens When Membership Changes

An operating agreement should outline what happens when new business members are added, or when existing ones leave. For example, let’s say there are three members to the business but after a few years one of them wants to sell his interest. What do the other members do? This is something that would be outlined in the operating agreement.

How Distributions are Made

Another point you’ll want in the operating agreement is how profits are distributed. Just because a member owns more equity in the business doesn’t always mean he must get a bigger share of the profits. This is something that would be clearly described in the operating agreement.

A Plan for Dissolution

How about if the members decide to close the business? This is often a tricky situation, with lots of emotion involved. How are assets distributed? What happens to the money that is generated from the sale of the assets? You’ll want this clearly defined in the operating agreement.

There are many other aspects that should be considered besides the examples given, but the point is, an operating agreement is as the name suggests: an agreement. Though they may not be required by law, I can’t stress how important and valuable they are for your business and your sanity.

Why Do I Need an Operating Agreement?

If the information above didn't convince you yet, there are a few different reasons why you should have an operating agreement. A few states, such as California and New York, legally require businesses to have operating agreements. We strongly recommend an operating agreement if you have a multi-member LLC or a single-member LLC.

Pros of having an operating agreement include:

  • Your LLC will be governed by your own rules. Without an operating agreement, you must abide by the rules of the state you're located in rather than whatever you laid out in your operating agreement.

  • Prevent expensive headaches. It's important to do things right while setting up your business so you don't face costly issues down the line.

  • You'll be prepared for major business decisions and events. The operating agreement outlines exactly how important business decisions will be handled.

What Do I Do After Creating an Operating Agreement?

After completing your operating agreement, that's pretty much it! As long as your business doesn't operate in one of the states that legally require an operating agreement, you're good to go! Creating the agreement is the most difficult part of the process.

If you're looking for advice on what to do next for your business in general, we've put together a guide on three things to do after organizing an LLC or incorporating.

Don't Just Use a Free Operating Agreement Template

There are many different websites advertising free templates for operating agreements, however, it's best to avoid these. If you're creating and using a legally binding business document, it's important it was created for your business and the state you operate in.

We recommend partnering up with an experienced business attorney at atCAUSE Law! We offer flat-fee pricing, so you don't have to worry about being surprised with an expensive bill. Contact us today to get started!

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