An LLC is a business structure in the United States that shields its owners from personal accountability for the company’s debts and obligations. LLC’s are considered “hybrid businesses” because they combine elements of a corporation and a partnership or a sole proprietorship into one entity.

For small business owners, forming an LLC can be a bit easier because its application process requires basic information about your business entity. In addition, having an operating agreement that outlines the financial decision-making and core functions of your LLC can save you time, money, and conflict.

Read this article to learn more about an operating agreement and how it functions for your startup and small business formation.

Why Do You Need an Operating Agreement?

An operating agreement does three things:

1. Shields members from personal liability to the LLC. If you don’t do this, your LLC could look a lot like a sole proprietorship or a partnership, which could put you at risk for personal liability.

2. Protects your LLC under the state. LLCs that don’t have an official operating agreement are governed by the rules of the state. This means that each state has a list of rules that apply to businesses that don’t sign operating agreements. It is not recommended for you to rely on the state’s governing body to handle your agreement.

3. Helps to clarify verbal agreements. If members have verbally agreed to particular conditions, there is still the possibility of misunderstanding or misinterpretation taking place. It is always to everyone’s benefit to have the operational conditions and any other business arrangements addressed in writing so that they may be referred to in the event that there is any controversy.

Do You Need an Operating Agreement for a Single-Member LLC?

Having an operating agreement is a legal requirement under state law in six states (California; Delaware; Maine; Missouri; Nebraska; and New York). Single-member LLCs, although being simpler in form than multi-member LLCs, can nevertheless benefit from having an operating agreement in order to avoid unnecessary stress and difficulty.

What Should Be Included in an Operating Agreement?

Your business’s operating agreement should include:

1. Ownership percentages

2. Allocation of profits 

3. The management structure

4. Roles and responsibilities of the members (multi-member LLC)

5. The decision-making process (voting rights, member’s rights, member meetings)

6. Process of closing the business

Article I: Organization

When an LLC is formed at the state level, it is required to file articles of organization — a formal legal document. It is through the use of these resources that the LLC and its members are able to establish their rights, powers, responsibilities, liabilities, and other obligations to each other and to themselves.

The operating agreement begins with a section dedicated to the formation of the business. It addresses the formation of the business, the composition of the board of directors, and the ownership structure. It is possible for numerous individuals to have equal or differing ownership stakes in a company.

Article II: Management and Voting

How the business is run and how its members vote are covered in this section of the document.

When a corporation has more than one member, the operating agreement stipulates how much power each person has over company matters. Voting may be used by the corporation to make choices. One vote per member, one vote per unit of ownership interest (if the ownership of the company is specified in terms of units). Depending on your business’s operating agreement, a specific number of votes may be necessary for certain corporate activities.

Article III: Capital Contributions

This section details the members of the LLC who have contributed funds toward the business’s first launch. Additionally, it describes how extra funds will be generated by the members of the organization. For instance, a limited liability company (LLC) may decide to sell ownership “units” in exchange for monetary contributions.

Article IV: Distributions

This part of the operating agreement will detail how the earnings and losses of the business will be distributed among the members. This may be monetary funds, actual property, or many other assets or additional capital owned by the company.

Article V: Membership Changes

Under membership changes, the operating agreement will explain the procedure for adding new members or deleting existing ones. It also specifies if and under what circumstances members are permitted to transfer their ownership of the company. For instance, your business will want to clarify what will take place in the event that a member passes away, a member declares bankruptcy, two members divorce, or any other similar event.

Article VI: Dissolution

In this part of the operating agreement, the conditions under which your business may or must be dissolved will be outlined. This process is referred to as “winding up” the affairs of the corporation at other times.

How Much Does an Operating Agreement Cost?

An easy and free do-it-yourself option for establishing an operating agreement is to follow a blank template or step-by-step instructions. You may find many different variants of these on the internet at various law libraries and on websites that provide legal assistance. The most significant challenge that you can have is determining whether or not the guidelines that you want to adhere to include a clause that is suitable for the kind of business you run.

However, if you don’t trust that your legal knowledge is up to par or prefer to contact a law firm or someone with legal expertise, it will cost you. According to various websites, hiring an attorney, registered agent, or legal expert to create your operating agreement can cost anywhere from $100 to upwards of $1,000.

Who Signs an Operating Agreement?

The members of the LLC sign the operating agreement. Once these members sign, it binds them to the term just like a contract.

Does an Operating Agreement Show Ownership?

Each party’s ownership stake in the LLC is clearly defined in the operating agreement. You may divide up ownership in an LLC in any way you wish, although it’s common for members to possess a portion of the company based on their contributions to its establishment, such as monetary investments.

What Is the Difference Between Bylaws and an Operating Agreement?

Bylaws are the company’s internal rules and regulations. In a nutshell, operational agreements define the internal running processes of an LLC, which is equivalent to a corporation. The primary distinction between an LLC and a corporation is the creation of bylaws for the former and operating agreements for the latter. 

Does an Operating Agreement Need to be Notarized?

The operating agreement is deemed to be legally binding between the parties, despite the fact that it has not been notarized. Nevertheless, there are certain companies that will still get the signatures notarized in order to give the impression that everything is more legitimate.

Do I Need an Operating Agreement to Open a Bank Account?

Having a documented operating agreement is not needed in all states, but it is strongly suggested because certain banks require this. Any LLC with several members, an LLC manager, or the desire to lessen personal responsibility, will profit from this arrangement.

Final Thoughts

Obtaining an operating agreement for your LLC can establish order, identify members, distribute responsibilities, and help with disseminating decision-making tasks. Although an operating agreement can be free by doing it yourself, in the event you need to hire someone, Nav offers financing options such as small business loans or business credit cards that may help cover the costs.

And if your business has yet to learn how to establish business credit, check here to increase your chances of getting the financing you need to cover expenses like forming an operating agreement.