An operating agreement is a fundamental legal document that all LLCs should have in place. Operating agreements outline both the LLC’s financial and functional decisions, including the business structure and the roles and responsibilities of its members and/or managers. As a result, the terms of the operating agreement direct the internal mechanics of the business and align the goals of its members by contractually binding them to its terms. 

Only six states legally require that LLCs draft an operating agreement: California, Delaware, Maine, Missouri, Nebraska and New York. Although other LLCs are not legally required to draft an operating agreement, having one drafted from the outset of starting a business can help an early company build a sustainable foundation to grow from. For LLCs in particular, operating agreements help to fully protect the company from any liability by formally expressing the business’s corporate structure which, in the LLC context, helps shield members from personal liability.

An operating agreement also codifies any oral agreements that were made between members that were not formally expressed in the Articles of Organization. Although the Articles do not express the ownership of the business, the operating agreement does. It also provides a framework for the operating procedures agreed upon by members.

Operating agreements are particularly useful for customizing solutions to prevent member disputes, and help to solidify agreements between members. For example, in the event that one of the owners of a business decides to transfer their interest, an operating agreement can prevent the default state laws from controlling buy-out and buy-sell rules. But, for these provisions to be legally enforceable, the members of the LLC must be following the other provisions of the operating agreement to legitimize it.

In the case of early stage startups looking to fundraise, having all the business records in order can be a positive signal to a potential investor. A governing document like an operating agreement can accurately describe the framework for operations and clearly establishes the governance structure of the entity. 

Conclusion 

As companies grow, conflicts between members will likely arise. Drafting an operating agreement is a preemptive measure to facilitate the resolution of any potential disagreements and ensures that all potential areas of disagreement will be adequately addressed ahead of time. If your business is looking to draft an operating agreement, consider consulting Founders Law for your formation and incorporation needs. 

‍Hind Abdelaziz is a startup and venture capital attorney based in Chicago, IL. She routinely represents founders, startups and venture capital funds in a wide variety of corporate transactions, including counseling clients on tax issues and navigating other matters associated with rapidly-growing startups. She can be reached at habdelaziz@founderslaw.com.