All About Operating Agreements

All About Operating Agreements

An operating agreement is a document that outlines the internal rules and procedures for managing and operating a Limited Liability Company (LLC). If you don’t have a document that you and your partners have agreed to, then you’re at the mercy of the default operating agreement that’s provided by your state. Avoiding the state default rules is critical so you can decide how your business is structured, not someone else.

An operating agreement is a foundational document that outlines the internal rules and procedures for managing and operating a limited liability company (LLC). It defines how your business will be run, how decisions will be made, and how profits and losses will be distributed.

Even if your state doesn’t require you to file one, having an operating agreement is a best practice for all LLCs – whether you’re a solo entrepreneur or part of a team. Without one, your business is at the mercy of your state’s default rules, which may not reflect your intentions or protect your interests.

Every LLC needs one – even single-member LLCs

Many single-member LLC owners assume they don’t need an operating agreement. However, an operating agreement is still critical. It helps:

• Reinforce the LLC’s separate legal identity, which is essential for maintaining limited liability protection.
• Clarify business operations, such as how profits are handled or how the business can be sold or transferred.
• Prepare for future growth, such as bringing in new partners or investors.

Courts and creditors may scrutinize your LLC’s structure in legal disputes. Having a signed operating agreement shows your business is a legitimate, separate entity – not just an extension of you.

Financial institutions may require it

Even if your state doesn’t mandate an operating agreement, many banks and credit unions – including Sound Credit Union – require one to open a business account or apply for financing. It helps to verify your authority to act on behalf of the LLC and outlines who can make financial decisions.

Benefits of an Operating Agreement

When you start a business with other people, it’s common to be too busy to worry about an Operating Agreement. The longer you leave it undone, the more issues you could face down the road.

An operating agreement makes crystal clear:

• Ownership and management structure, including percentage of ownership and voting rights.
• Roles and responsibilities, so tasks don’t overlap and employees know who to report to.
• Meeting procedures, including frequency and content.
• Profit and loss distribution, which can be customized beyond equal shares.
• Salaries, bonuses, and compensation.
• Transfer of ownership, including what happens if a member leaves, sells, or passes away.
• Dispute resolution processes.

Without an agreement, your LLC may be forced to dissolve if a member exits or passes away.

Protecting Your Limited Liability

One of the core benefits of forming an LLC is limiting your personal liability, but that protection can be weakened if your business appears informal or disorganized. An operating agreement helps prove that your LLC is a real business entity, not just a shell for avoiding liability.

Avoiding the State Default Rules

A good example of most state operating agreement rules, is the equal division of profits and losses, which can put you at a disadvantage. You may not want the split of profits to be the same as ownership, for example, one person may have a larger percentage of shares but not work the same hours in the business, or work at all. In this case, you may want their distribution of profits less than their percentage of ownership. If a new member buys into your LLC, you may not want them to receive a full share of the profit immediately (as they didn’t shared the initial risk at start-up). Even more problematic, some state operating agreements require leaving members to be paid fair market value for their shares. Often, smaller LLC’s can’t afford to buy out departing members, or have to borrow the money to do so, which can cause the LLC to be dissolved. State operating agreements don’t tend to have the flexibility to cater for these situations.

Solving Future Disputes

Nobody thinks they will end up arguing with a business partner, but financial or strategic stresses can take their toll. When a difference of opinion occurs, it is important to have a clear and definitive set of written rules by which the disagreements can be resolved.

The failure to enter into a written operating agreement raises the possibility that a member could say there was an oral operating agreement, which is open to interpretation (and ‘you said’, ‘they said’). Even if you did promise something verbally at the start of the business such as ‘we’ll split profits evenly’, circumstances can change when this is no longer the case, for example, one member cuts hours to part time.

Any business that operates as an LLC should consider creating an operating agreement sooner rather than later. It will require an investment of time and money, but the benefits of creating your own clear set of written rules outweigh any associated costs.

Next Steps

• Discuss with the other owners of your business the need for an operating agreement.
• There is a Washington State eform you can complete which provides the basics. If your business was formed outside Washington, search your state here.
• LLC Washington has free Word or PDF operating agreements you can download to make a start.
• Contact your business adviser, accountant or solicitor to make sure you have everything covered. Filling in a template is fine to begin with, but isn’t the same as getting expert advice for your specific situation and customizing the agreement for what you want.

Final thoughts

Whether you’re a solo founder or part of a team, an operating agreement is one of the smartest steps you can take to protect your business and yourself. It’s not just a legal formality; it’s a roadmap for how your LLC operates and grows.

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