How to File an Operating Agreement

This week on the ABC’s of MyCorp, we’re focusing on the letter “O” for operating agreement. State laws are fairly lax when it comes to operating agreements – a handful of states require that an operating agreement be drafted, and even fewer require that Limited Liability Companies hold onto written copies of it. So, typically, LLCs choose to either forgo creating an operating agreement, or simply say that their operating agreement was agreed to orally.

However, the lack of government oversight for operating agreements does not make them any less important or valuable. Even if your LLC was created in a state without laws governing operating agreements, it is still a good idea to draft one and keep copies of it on hand for a few important reasons.

First, it cements your company’s status as an LLC and protects your, and your partner’s, personal liability. Yes, filing the paperwork and making your business an LLC in the eyes of the state does separate your assets from the business’s, but if debtors push you into court, having an operating agreement on hand will help to ensure that the court will see your company as a legitimate LLC.

It also helps to protect you if a business partnership turns sour. Oral agreements are all well and good when everyone likes one another, but how do you prove something was agreed to orally without a tape of the conversation? It is better to be safe than to be sorry, and putting all of the agreements between the members of an LLC into writing will help protect the interests of each and every member.

You should also be sure to clearly outline how ownership of the LLC is distributed amongst its members. Usually the percentage of ownership corresponds to how much investment capital a member gave to the LLC, but LLCs can divvy up ownership percentages on its own terms, and putting those terms and the corresponding percentages in an operating agreement is extremely important, especially if percentage of ownership is not directly influenced by investment.

The same concept is applicable to how an LLC distributes its profits and losses, especially if the LLC chooses to create its own system for its distributive share scheme. Profits and losses for an LLC are normally recorded as income for the LLC’s members as an LLC typically has a pass-through tax structure, and so the operating agreement should outline the system for, and frequency of, the distribution of profit and losses.

Finally, in the case of a member’s death, any agreement on the re-distribution of ownership should be made explicit in the operating agreement. An unexpected death or severe illness can cause a lot of turmoil within an LLC, and the last thing you want is for your business to be torn apart from internal bickering or threats of lawsuits. You can also take steps towards protecting your LLC from being dissolved by specifying specific conditions under which dissolution would be acceptable.

Clearly, an acceptable, comprehensive operating agreement is an essential part of forming a Limited Liability Company, even if your state’s government does not require LLCs to have one. Operating agreements are a great way to protect your assets and your interest in the company, so when you begin preparing to form an LLC, take the time to draft an operating agreement, or have one prepared for you. You’ll be happy to have that extra bit of insurance if things get a little rocky down the road.