What Is An LLC Operating Agreement and Why Are They Needed?

Starting a business can be a very exciting time for everyone involved. The possibilities seem endless and you are finally running the show. You have a vision and you can execute on it without anyone holding you back. Most importantly, you are your own boss and you don’t have to answer to anyone, which can be liberating.

Before you jump into the deep end and hit the ground running it is prudent to think through a few crucial items first. You will need to file your LLC with the secretary of state and create articles of incorporation. A critical step to guard your LLC is the operating agreement, which will lay out the details of your business, including the responsibilities of everyone involved and how decisions will be made.

What Is An Operating Agreement?

An operating agreement is a legal document that explains how certain parts of a business function. The IRS has guidelines for an operating agreement but each state has its own laws and regulations. Basic requirements usually include, definitions, permitted businesses of your entity, management details, member’s rights, and how to withdraw from your LLC.

The ownership percentages, structure, and contributions and distributions come into play when dealing with taxes. For example, if you are taxed as a partnership you must keep track of your basis which can be impacted by contributions and distributions made to and from the business throughout the year. Having a professional accountant or CPA will help you keep track of your basis in your business.

Who Needs An Operating Agreement?

Operating agreements are used for members of an LLC or limited liability company. Each state dictates if an operating agreement is required, so be sure to check your state laws. Regardless, it is wise to set up an operating agreement to avoid confusion and make business functions easier and more efficient.

This will help in making decisions in the business with members. If you need to vote on certain strategic decisions for example or buy a partner out the operating agreement can dictate how these things will be handled.

How To Create An Operating Agreement

Get an attorney who specializes in business law. You can DIY the document by using online services such as LegalZoom or RocketLawyer but I would advise against this.

I believe it is worth your while to pay the extra money to speak to an attorney who specializes in business. They will have the experience and knowledge to ask you the right questions to ensure your LLC is set up appropriately, so you can avoid headaches down the line. Be sure to speak with an attorney who is licensed in your state, or whichever state you will be incorporated with.

When Do You Need To Make Changes To Your Operating Agreement?

It is important to review your operating agreement each year or when things change in your business. If you have a member who leaves the business or is bought out it would be a good idea to amend the agreement as necessary.

Typically, you can go back to the original attorney for any amendments for a fraction of the price. These things are usually dictated in their initial fees as things in business and legal documents need to be fluid to accommodate the new adjustments.

If you are an owner of an LLC, do yourself a favor and review your operating agreement with an attorney to make sure it is up to date. If you do not have one, then seek out an attorney to help you draft one to ensure it gets done correctly. This is even more important as you grow and take on new ownership and investment.

If you’d like an objective second opinion about your finances, please contact Michael Shea, a CERTIFIED FINANCIAL PLANNER, at Applied Capital. Email him at [email protected] or fill out a contact form.

This blog is provided for informational purposes only. Such views are subject to change at any point without notice. The information in the blog should not be considered investment or tax advice or a recommendation to buy or sell any types of securities. Some of our blogs or information therein have been obtained from third party sources believed to be reliable but such information is not guaranteed. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular investor’s financial situation or risk tolerance. No reliance should be placed on, and no guarantee should be assumed from, any such statements or forecasts when making any investment decision.

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