Why Does an Operating Agreement Matter?

By: Sophia Chase Munson

1. The operating agreement is the document that lays out the governance and succession of the business.

The operating agreement is the document that lays out the governance and succession of the business. This means that it explains when and under what circumstances meetings can be held, the rights and responsibilities of the business owners and managers, appropriate limitations of liability, procedures for the addition of a new business partner, procedures for the departure of a business partner, and when and how a business should be ended. It may also include provisions like intellectual property protections, confidentiality restrictions, and non-compete or non-solicitation requirements.

2. This agreement is a plan of business operations.

Many small business owners find that putting together the operating agreement helps them identify questions they had not even thought to ask about before beginning business, such as how the business will be managed between partners; how the business interacts with their estate plan; and how business interests may be bought and sold. The operating agreement states how the business is going to be run, so a court (or a bank, or an investor, or the government…) know what to expect. LLC owners should also actually follow the terms of the operating agreement (that means not printing it out and sticking it in a desk drawer for ten years!).

3. Operating Agreements serve as proof that an LLC is truly acting as a separate business in the case of a lawsuit.

When an individual or individuals set up an LLC, they are doing so to create a separate entity—separate from themselves personally—through which to conduct business. They generally do this to try to limit access to their personal assets, so that if a third party sues them because of a business issue, the third party cannot reach that business owner’s personal funds and home.

However, to prove that an LLC is truly acting as a separate business in the case of a lawsuit, a court requires proof that the LLC is not simply a thinly veiled attempt by the business owner to claim protection that he or she is not entitled to. This is why it is very important that you treat your business as a business, not just an informal convenience. A business should have a business plan and a succession plan, because that is how successful and organized business is conducted.

4. An operating agreement is a vital document for the court, for investors, for any banks requiring a loan, and to receive certification from the government for any kind of small business certification, amongst many other things!

Many clients come to us with form operating agreements printed from the internet, which they do not understand and have not been followed. These are not effective. We recommend consulting with attorneys who are experienced working with these documents, and know how to craft a document that will actually reflect your business practices.

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#businessformation #operatingagreement #governance