An operating agreement outlines a business’ structure, including ownership, capital contributions, and member responsibilities. Check out this step-by-step guide for what your agreement should include.
Businesses and organizations should draft operating agreements to ensure business is conducted properly and investments are protected. An operating agreement is as critical as your strategic plan or annual operating plan in helping to achieve your business goals and enabling your organization to grow year over year. It outlines the structure of your business, including ownership, capital contributions, member responsibilities, and internal operations.
A written operating agreement also guides the decisions of the senior management and the board of directors. This comprehensive guide breaks down what an operating agreement is, why it is essential, and how to write one. Read on to find out more and learn how our board governance solution can help you streamline this process.
What is an Operating Agreement?
An operating agreement identifies a limited liability company (LLC), states its ownership, lays out the business structure, and defines member duties. The document customizes the terms of an LLC to meet its members’ particular requirements. Additionally, it describes the structured approach of how management and board members make operational and financial decisions.
Once each registered agent has signed the agreement, it becomes a legally enforceable set of rules that must be followed by members of a limited liability company. The operating agreement should include the following:
- Basic information about the business, such as official name, location, statement of purpose, and registered agent
- Tax treatment preference
- Member information
- Management structure
- Operating procedures
- Liability statement
- Additional provisions
The operating agreement creates a legal buffer between LLCs and their directors or owners. It prevents them from the liability of the LLC’s obligations, so creditors cannot pursue their personal assets upon liquidation. Furthermore, the operating agreement enables owners to formalize governance processes, such as voting and board meetings or the terms of their company’s succession.
How to Write an Operating Agreement
The following is a step-by-step guide for writing your operating agreement.
1. Outline Ownership
Usually, LLC owners provide the initial capital to start the business in the form of assets, money, or services. As a result, each LLC member receives a portion of the company’s assets in exchange. Members are free to distribute ownership however they like.
LLC members divide ownership according to the capital share that each contributed. Therefore, the operating agreement should include a detailed description of these contributions and percentage interests.
Apart from the ownership interests for financial contributions, LLC owners also receive shares of the company’s profits and losses, called distributive shares. Accordingly, all LLC parties should review the ownership section of the agreement to confirm the fair allocation of assets, losses, profits, and shares.
2. Define Ownership Rights, Responsibilities, and Compensation
One crucial element of the operating agreement is membership protection. It covers each LLC member’s rights and obligations, including voting, compensation, daily duties, performance, and meeting requirements.
Meeting provisions and voting rights are closely intertwined since members vote on significant issues during meetings. The voting provisions specify members’ voting share and whether a simple majority finalizes a vote. Finally, the document should define how amendments to the operating agreement are made, voted on, and implemented.
3. Define Dissolution Terms
An operating agreement must cover the potential that members may desire to dissolve the company at some point. In most cases, all members must vote to start the process. Dissolving an LLC involves submitting the required paperwork, liquidating assets, and paying debts. Members can then divide the remaining assets among themselves per the stipulated wind-down procedures.
Are LLCs Required to Form an Operating Agreement?
Most states don’t require LLCs to file or provide proof of a functional operating agreement. Therefore, businesses can keep these documents confidential. They can also update the agreement as necessary to guide normal daily operations and help resolve arising disputes.
Understanding the Board's Role
Often, private companies can approach the formation of a board of directors however they choose or set out in their operating agreement. For instance, members might opt to have only certain members elect board directors or require the founders to always sit as directors.
Therefore, the formation of the operating agreement, company bylaws, or articles of incorporation typically precedes the formation of the board of directors. Still, LLCs sometimes form the board of directors, who then proceed to develop the operating agreement.
Unlocking the Power of Board Management
An operating agreement outlines an LLC’s structure, including ownership, management structure, capital contributions, and member contributions. Writing an operating agreement requires outlining ownership, defining ownership rights and compensation, and defining the dissolution terms.
As technology continues to play a crucial role in overall business processes and management, many companies are exploring different ways of using it to improve their operations and corporate governance framework.
OnBoard, a purpose-built board portal platform, comes equipped with enterprise-grade document storage to house your operating agreement and other crucial business documents, like your board resolution or indemnity agreement. Its easy-to-use platform includes chat and videoconferencing capabilities so board members can move more quickly, operate more effectively, and accomplish more — from anywhere.
Check out OnBoard’s Board Effectiveness Survey to learn more about the trends driving board effectiveness into the future.
Frequently Asked Questions (FAQ)
What is the Purpose of the Operating Agreement?
An operating agreement outlines an LLC's financial and functional decisions, including ownership, provisions, rules, and regulations. It governs the business' internal operations to suit the specific needs of the owners.
What Should an Operating Agreement Include?
An operating agreement should include the following:
- Percentage of members' ownership
- Meeting provisions and voting rights
- Powers and duties of members and management
- Distribution of profits and losses
- Tax treatment preference
- A liability statement
- Management structure
- Operating procedures
About The Author
- Josh Palmer serves as OnBoard's Head of Content. An experienced content creator, his previous roles have spanned numerous industries including B2C and B2B home improvement, healthcare, and software-as-a-service (SaaS). An Indianapolis native and graduate of Indiana University, Palmer currently resides in Fishers, Ind.
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