What is an Operating Agreement?
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What is in an Operating Agreement and how does it protect you? If you have an LLC or are thinking about forming an LLC, you’ve probably heard or read that you need an operating agreement, but you many not be clear as to what functions an operating agreement serve. In a nutshell, once adopted by its owners, an operating agreement becomes the official governing document for an LLC, An operating agreement is absolutely essential if you're going into business with partners, It's important for owners to have separate evidence of what rights and obligations they have to the business, but an operating agreement is also one of the key foundational building blocks for establishing the LLC as a legal entity that is separate from its owner(s) so it can serve an important function even if you're the sole owner of your LLC. |
Although a sole owner of an LLC may not need an operating agreement for the purpose of dealing with other owners, it is still important. An individual chooses to do business through a limited liability company or corporation for two reasons. The most important reason is to gain limited liability for the owner(s). However, an LLC and its owner(s) must earn this limited liability. As mentioned above, this limitation of liability is achieved if the LLC is treated as a separate entity from the business owner. Also, an operating agreement naming a springing member, in conjunction with a simple springing member agreement, is important for the continuation of your business and the protection of your business assets in the event you pass away at any time when you're the only owner of your business.
In this video, the key components of an operating agreement are explained, including:
Springing Member Provisions: Importantly, under Arizona law if a sole member of an LLC dies, the LLC automatically ceases to exist. If the LLC ceases to exist, how can it fulfill or close out its contracts, accept payment for services or goods that were delivered prior to the owner’s death, or sell real property or other assets owned by the LLC?
To prevent this unintended and extremely problematic outcome, our operating agreements all contain a “springing member” provision, which is authorized under Arizona law. The springing member is a person who is authorized to sign and file the necessary documents with the Arizona Corporation Commission to bring in a new member who, based on your instructions, will either wind up the affairs of the business and dissolve it or will continue the business operations.
You should always get any type of agreement in writing before a dispute arises. A well drafted operating agreement will address, in advance and in writing, a number of potential issues and how they are to be resolved. A customized operating agreement that lays out the owners’ intention as to how the business will operate and specifies a procedure for dealing with disagreements can minimize the damage created by such a disagreement.
In summary, an operating agreement will help guard your limited liability status, head off financial and management misunderstandings, provide verification required by banks and other parties, and ensure that your business is governed by your own rules. An LLC operating agreement allows you to structure your financial and working relationships with your co-owners in a way that suits your business. Moreover, without an operating agreement, you and your co-owners will be ill-equipped to settle misunderstandings over finances and management.
To discuss establishing an operating agreement for your LLC or to find out whether the operating agreement you’re using is, in fact, sufficiently customized to reflect your intention as it relates to your business, call Jeana Morrissey at 480-556-1902 or email her at [email protected].
If you are going into business with partners, you should also consider entering into an LLC Member Buy-Sell Agreement.
In addition to an operating agreement, the owners can and should enter into a Membership Interest Buy Sell Agreement early in the life of the business to address important matters in depth before particular situations or triggering events occur. The Buy Sell Agreement will clearly lay out the framework for addressing these matters, such as:
To further discuss these issues and the merits of establishing a buy-sell agreement between the members of your LLC, call Jeana Morrissey at 480-556-1902 or email her at [email protected].
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In this video, the key components of an operating agreement are explained, including:
- the existence of the LLC and its identity separate from its owners;
- the percentage ownership interest of the members;
- what compensation was paid or is to be paid by each member for those interests;
- the voting rights of the members;
- whether the business will be managed by the members or managers;
- who runs the business, and the roles and responsibilities of the owners and manager(s);
- under what circumstances a membership interest may be forfeited;
- the process for resolving disputes that arise between members; and
- the circumstances under which membership interests can be transferred; and
- the requirements for any new member to be accepted into the business.
Springing Member Provisions: Importantly, under Arizona law if a sole member of an LLC dies, the LLC automatically ceases to exist. If the LLC ceases to exist, how can it fulfill or close out its contracts, accept payment for services or goods that were delivered prior to the owner’s death, or sell real property or other assets owned by the LLC?
To prevent this unintended and extremely problematic outcome, our operating agreements all contain a “springing member” provision, which is authorized under Arizona law. The springing member is a person who is authorized to sign and file the necessary documents with the Arizona Corporation Commission to bring in a new member who, based on your instructions, will either wind up the affairs of the business and dissolve it or will continue the business operations.
You should always get any type of agreement in writing before a dispute arises. A well drafted operating agreement will address, in advance and in writing, a number of potential issues and how they are to be resolved. A customized operating agreement that lays out the owners’ intention as to how the business will operate and specifies a procedure for dealing with disagreements can minimize the damage created by such a disagreement.
In summary, an operating agreement will help guard your limited liability status, head off financial and management misunderstandings, provide verification required by banks and other parties, and ensure that your business is governed by your own rules. An LLC operating agreement allows you to structure your financial and working relationships with your co-owners in a way that suits your business. Moreover, without an operating agreement, you and your co-owners will be ill-equipped to settle misunderstandings over finances and management.
To discuss establishing an operating agreement for your LLC or to find out whether the operating agreement you’re using is, in fact, sufficiently customized to reflect your intention as it relates to your business, call Jeana Morrissey at 480-556-1902 or email her at [email protected].
If you are going into business with partners, you should also consider entering into an LLC Member Buy-Sell Agreement.
In addition to an operating agreement, the owners can and should enter into a Membership Interest Buy Sell Agreement early in the life of the business to address important matters in depth before particular situations or triggering events occur. The Buy Sell Agreement will clearly lay out the framework for addressing these matters, such as:
- In what situations can members sell or transfer their interests and to whom are transfers allowed?
- How is the sale price of the membership interests to be determined?
- Do the other members get the right of first refusal in any situation involving the sale or transfer of membership interests?
- If a member dies, is the member’s estate required to sell the deceased member’s share to the LLC or other members?
- And many other important matters
To further discuss these issues and the merits of establishing a buy-sell agreement between the members of your LLC, call Jeana Morrissey at 480-556-1902 or email her at [email protected].
Back to Helpful Articles and Information page