What Is an Operating Agreement?
In the business world, many legal documents serve as guiding principles for how an organization operates. One such document, often overlooked by new entrepreneurs, is the operating agreement. This crucial legal document outlines the operational and financial decisions of a company.
An operating agreement is a legal document that outlines the ownership structure, member roles, and operating procedures of a limited liability company (LLC). It provides a framework for the company’s operations and clearly delineates its members’ rights, powers, duties, liabilities, and obligations. It is not mandatory to have in all jurisdictions, but it is highly recommended because it helps prevent misunderstandings among the owners and protects their legal rights.
Importance of an Operating Agreement
An operating agreement is vital to establishing your LLC’s credibility and legality. It lays the groundwork for your company’s financial and working relationships among business owners, known as members. Without it, your LLC would be governed by your state’s default rules, which may not be beneficial or suitable for your business. Having a well-drafted operating agreement ensures that your business operations align with your specific management style and investment goals.
Key Sections in an Operating Agreement
An operating agreement typically includes sections such as:
- Organization: This section outlines the formation details of the LLC, including the date of formation, members, and structure.
- Management and voting: Here, the management structure of the LLC is defined, including voting rights and responsibilities of members and managers.
- Capital contributions: This section describes the contributions made by each member to the LLC, whether in cash, property, or services.
- Distributions: This section details how the company’s profits and losses are shared among members.
- Membership changes: This section explains the process for adding or removing members and what happens in the event of a member’s death or bankruptcy.
- Dissolution: This section establishes the circumstances under which the LLC may be dissolved.
Operating Agreement Vs. Articles of Incorporation
While the operating agreement and articles of incorporation are critical legal documents for a business, they serve different purposes and are used by different businesses. LLCs use the operating agreement, while corporations use the articles of incorporation.
The articles of incorporation establish a corporation’s existence and include information about the type of business, the number of shares the corporation is authorized to issue, and the names of the initial board of directors. On the other hand, the operating agreement is much more detailed and includes comprehensive information on how the LLC will be run.
Pros of Operating Agreements
Operating agreements can help avoid a multitude of potential headaches, such as:
- Ownership disputes: An operating agreement can prevent member disputes by clearly delineating ownership percentages and responsibilities.
- Financial misunderstandings: Defining how profits and losses are allocated can prevent financial misunderstandings among members.
- Default state rules: Without an operating agreement, your LLC would be governed by your state’s default rules, which may not suit your business needs.
Our Annapolis Business Lawyers at Oliveri & Larsen Can Help Your Business Get Up and Running
Starting a business is exciting but comes with challenges. For legal help, speak with our Annapolis business lawyers at Oliveri & Larsen. Call us at 410-295-3000 or contact us online to schedule a consultation. Located in Annapolis, Maryland, we serve clients in Ocean City, Anne Arundel County, Baltimore County, Baltimore City, Calvert County, Harford County, Howard County, Queen Anne’s County, St. Mary’s County, Worcester County, Kent County, and the upper and lower Eastern Shores of Maryland.