What is an Operating Agreement?

You have likely filed your paperwork with the state to form your Limited Liability Company. You probably have an EIN and are ready to open a bank account. But then the banker asks for your Operating Agreement. This is often the first time a new founder realizes they missed a step.

An Operating Agreement is a key document used by LLCs to outline the business’s financial and functional decisions including rules, regulations, and provisions. Unlike the Articles of Organization which you file with the state, the Operating Agreement is an internal document.

It acts as the governing contract between the members of the company. It sits in your records and dictates how the business runs.

Many founders skip this step because the state does not always legally require it. That is a mistake.

If you do not have an Operating Agreement, your business is governed by the default laws of the state where you formed the company. These general laws are rarely optimized for a specific startup environment. They might dictate how profits are split or how the company must be dissolved in ways you do not agree with.

Having this document allows you to override those default rules. It creates a custom framework for your specific situation.

It also helps preserve your limited liability status. If you are sued, the court will look to see if you are operating the business separately from your personal affairs. A formal Operating Agreement helps prove that separation.

While every business is unique, most agreements cover similar territory. You need to define who owns what. This includes the percentage of interest each member holds.

Next, you must outline how profits and losses are distributed. In an LLC, this does not always have to match ownership percentage, but it usually does. You need to write that down.

Management structure is another critical piece. You must decide if the company is member-managed, meaning all owners run the day-to-day, or manager-managed, where you appoint a specific person or group to handle operations.

Voting rights need clarity. Does a 1% owner have the same voting power as a 51% owner? Usually not, but you must specify how votes are counted.

It is easy to confuse the Operating Agreement with the Articles of Organization. They serve different purposes.

The Articles of Organization is a public document filed with the state. It is like a birth certificate for the business. It contains basic information like the name, address, and registered agent.

The Operating Agreement is private. It is much longer and more detailed. It acts as the bylaws and the partnership agreement rolled into one.

The most valuable part of this document is often the section on dissolution or transfer of interest. Startups are volatile.

Founders leave. People get divorced. Unfortunately, people die.

Your agreement needs a buy-sell provision. This dictates what happens if a member wants to sell their shares or leaves the company. It prevents an ex-spouse or an unknown third party from becoming your business partner.

It forces you to ask hard questions now so you do not have to fight about them later.