Operating Agreement: Why Do You Need One

Man signing an operating agreement

To create a business structure with more protection but with low formality, you need to establish a Limited Liability Company (LLC). Whether you’re the sole owner, or there are multiple partners, having an operating agreement will give it more credibility.

But what is an operating agreement, and does it have any other use than adding credibility?

What is an Operating Agreement?

An operating agreement is a key document in creating an LLC. It outlines the business’s functional decisions. These decisions include rules and regulations and any provision you require in your business.

Any financial the company takes will also be under the operating agreement. Financials play a major role in the strategic planning and decision-making of a business.

When there are multiple partners in a business, the operating agreement will act as an official contract. It binds the partners to its term once signed. The document will govern the internal operations of the company.

Man signing an operating agreement

Why Do You Need One?

If you’re forming an LLC, an operating agreement is necessary. It’s also beneficial in other ways.

1.     Protect Business Liability Status

An operating agreement protects the business’ limited liability status. When members sign this document, they gain protection from personal liability.

If you don’t have this formality, your LLC will resemble a sole proprietorship instead. It can also be like a partnership, which can jeopardize personal liability.

2.     Clarify Verbal Agreements

Even if you or your business partner verbally agreed to some terms, miscommunication can happen. Here you can stop conflicts from becoming exacerbated by having documented operation conditions in place.

partner receiving business registration consultancy

3.     Protect Your Agreement in State’s Eyes

If your LLC doesn’t have any operating agreement, it will be subject to default state rules. Since the state rules governing LLC are general, you shouldn’t rely on them to manage agreements.

4.     Outlines Functionality of Internal Affairs

It will outline all functional activities. You can refer to it in the event of conflict and misunderstandings. It entails ownership percentage, voting rights, profit and loss distribution, etc.

business partners forming an LLC

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