Operating agreement: Overview, definition, and example
What is an operating agreement?
An operating agreement is a legal document that outlines the ownership, structure, and management rules of a limited liability company (LLC). It serves as an internal contract among the LLC members, defining their rights, responsibilities, and how the business will be run.
For example, if two partners start an LLC together, the operating agreement can specify how profits will be shared, how decisions will be made, and what happens if one partner wants to leave the business.
Why is an operating agreement important?
An operating agreement is important because it helps prevent disputes by clearly defining each member’s role, financial contributions, and decision-making authority. It also provides legal protection by reinforcing the LLC’s separate identity from its owners, which can help maintain limited liability status.
In some states, an operating agreement is required by law. Even if it's not mandatory, having one can help an LLC avoid default state rules that may not align with the owners' preferences.
Understanding an operating agreement through an example
Imagine three friends start a graphic design business as an LLC. Their operating agreement outlines:
- How much money each person contributes to the business.
- How profits and losses will be shared.
- Who has the authority to make business decisions.
- What happens if one partner wants to sell their share or leave the business.
Without an operating agreement, disagreements could arise, and state laws might decide how the business is run—potentially in ways the owners don’t want.
An example of an operating agreement clause
Here’s how a clause in an operating agreement might appear:
“The Members agree that all decisions regarding the management and operation of the Company shall be made by majority vote unless otherwise specified in this Agreement. Each Member’s ownership percentage shall determine their voting power.”
Conclusion
An operating agreement sets the foundation for how an LLC is managed, protecting owners from disputes and ensuring smooth business operations. While not always legally required, it’s a crucial document that helps LLC members define their rights and responsibilities clearly.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.