What Is a Business Operating Agreement?

Before everything else is to be defined, it is important to know that whenever you require more protection in your business but seek fewer liabilities, forming an LLC, or a limited liability company is considered to be a good practice. And whenever you form an LLC for your business, it should have an operating agreement in place.

A business operating agreement is defined as a document that explains the financial and functional choices of the business, including its respective rules, regulations, and restrictions. The document’s objective is to manage the internal operations of the business in such a way that it meets the demands of the business owners. When the members of the limited liability corporation sign the paper, it becomes a legal contract that binds them to its conditions.

Purposes of Making a Business Operating Agreement

Why would a business operating agreement be necessary? Here are some answers to that question:

Scope of a Business Operating Agreement

What is the scope of a business operating agreement? Here are some of the necessary topics that this document should cover:

Percentage of Ownership. Each co-owner’s interest percentage in a limited liability company is generally decided by how much money that co-owner gave to the firm when it was founded in comparison to how much each co-owner contributed. Several reasons exist on why you would choose to share ownership. For example, a bigger percentage of profits can be rewarded to owners who put in more effort. However, the way in how you distribute ownership interests ultimately relies on your vision for the LLC and your specific circumstances. Because this will influence who takes crucial choices for your organization, it should be noted that you consider your ownership proportion carefully.Distribution of profits and losses. Co-owners of the limited liability company share in their respective gains and losses. Profits and losses are distributed through distributive shares. These percentages will be specified in your business operating agreement. On the other hand, LLC co-owners must pay taxes on the LLC’s income regardless of whether they are divided or not. Consider if everyone will have enough money to pay taxes if they don’t have access to their LLC profits.Duties and responsibilities of the manager and members. When creating this section, make sure your business operating agreement includes a management structure for your limited liability corporation. A good overview of how your LLC will be governed and what your company’s duties will be serves as the blueprint for how your day-to-day business operations are going to be conducted. You should also outline the procedures for effective decision-making in your LLC. Defining your LLC’s management structure and corporate functions helps prevent any form of future uncertainty and misunderstandings.Method of accounting. The operating agreement might also outline your company’s accounting technique and the fiscal year it will adopt. When making this element, you can consider employing an accountant to ensure that your financial statements are prepared in conformity with accounting standards. Operating agreements also usually include a clause requiring the limited liability company or its members or management to provide to their LLC’s co-owners an audited balance sheet and audited statements of operations and cash flow. This keeps everyone on the same page and up to date on the financial condition of the company.Rules for voting. When the business has a meeting and makes a decision that will have a substantial impact, a formal vote is normally required. You should provide your LLC with voting methods and regulations by detailing them in your operating agreement. To avoid state default rules, consider how much voting power each co-owner or director has. To have an effective vote, you must determine if a majority of votes is sufficient to approve a matter or whether a supermajority of shareholders must assent before an item is passed. It is also possible to make a decision unanimously.Terms for member withdrawal. It is also a good idea to include provisions in your operating agreement for what will eventually happen if one of your co-owners departs the company, either freely or involuntarily. This eventuality can be addressed in your operating agreement. You can also get into a buy and sell agreement, which requires a co-owner to sell his or her shares to the other co-owners (or just have the sale authorized by the co-owners) when the owner wishes to leave.Plans in case of dissolution. Though it may be intimidating to think about at first, it is always important that, in your operating agreement, you should plan for the dissolution of your limited liability company. This is because you don’t want the default rules to apply to the conclusion of your business, especially when circumstances appear to be getting worse. At the absolute least, you should consider what sort of vote will be necessary to dissolve the LLC and how the total value of the LLC will be distributed at the conclusion of its operating lifetime.

Factors That Affect a Business

There are different factors that affect the way a certain business is operated. Here are some of them:

Economical factors. The status of the economy has an impact on every component of a business’s everyday life, from employee well-being to a company’s capacity to prosper. When the economy weakens and unemployment rises, businesses may have to work harder to retain employees and change their processes in order to continue earning revenue. If the company manufactures products for retail sale, for example, they may consider lowering the price to increase sales and thus increase revenue.Social factors. Social factors include where people reside, what their personal values are, and their respective economic standing. When developing and marketing products, businesses consider social factors, and many use current events, movements, and social issues to appeal to their customers. Catering to the specific preferences and expectations of minority groups, who now have more market influence than in previous years, can also contribute to customer satisfaction and business growth.Ethical factors. Since each person has a distinct concept of morals and ethics, a few companies may encounter difficulties in balancing the personal lives of employees with their assumptions in the workplace. Employees’ pastimes, such as using social media accounts, can reflect on their employer’s profile. They have a responsibility as company representatives to avoid all types of behavior that could cause harm to the company. Managers can manage concerns such as the disclosure of sensitive information or the harassment of a coworker outside of work by creating standards and, where required, instituting disciplinary action.Natural factors. As awareness of environmental issues continues to grow, more customers are becoming aware of the environmental impact of company activities. Some customers have used their purchases to support businesses that utilize environmentally friendly methods such as biodegradable packaging and solar and wind power. Businesses may protect the environment, retain consumers, and boost income by paying attention to these external problems and modifying their processes.Demographical factors. Businesses with effective goods and services assess the demographic characteristics of their potential market to ensure that their offerings satisfy the demands of individuals who benefit from them. They also administer assessments to see how successfully they service their consumers. By conducting assessments, the results assist them in determining whether their intended market has evolved and how they may build better ways to service their loyal clients while also gaining new ones.Competitive factors. By taking note of their competition, businesses may expand their market share and remain relevant to their customers. They may recognize and assess accomplishments and issues, which result in understanding what to implement into their own processes and how to avoid income loss. They may also utilize the data they collect to generate suggestions for product improvements, relaunches, and the development of new products.

How to Create a Business Operating Agreement

Here are the steps that should be followed whenever a business operating agreement is to be created; Since businesses are different from each other, some unique steps may be needed to conform to your needs.

  • 1. Start With the Company Basics

    Every kind of business agreement, regardless of the deal and the size of the organization should have the company’s basic information written at the start. Begin this step (and this document) by writing the company’s name, its business address, the date that the company was formed or founded, and the important details of the registered agent. Make sure that all the information that is written down is accurate.

  • 2. Write the Information of the Members

    To follow-up, this step is accomplished by writing down the information of the company members. The information can include the members’ names, their respective contact details, their contributions to the company (which can include their capital, their assets, their services, or even their real property), each of their rights and responsibilities, and, if applicable to the situation, the details of the company manager or company officer. As with the first step, it is important to ensure that the information written down here is accurate.

  • 3. Write the Main Elements of the Agreement

    Now it is time to write the main elements of the business operating agreement. In this step, write down the accounting procedures that the business will follow. Each procedure will be unique to the type of business involved in the operating agreement. Also included here are other factors that describe how the business runs such as when their fiscal year will start and end, how their respective records will be kept, how the profits made by the company will be distributed and the respective duties and responsibilities of the manager of the business and their members.

  • 4. Follow-up With the Auxiliary Factors of the Agreement

    After writing the main elements of the operating agreement in the previous step, it is now time to write the auxiliary elements of the document such as any other processes that the company can undertake. These can include the voting rules and procedures of the members of the company, terms that dictate what will happen in case any member of the company leaves, is found to be incompetent, or in case the member dies, and any plans to follow in case the limited liability company will enter dissolution.

  • 5. Verify the Entire Document

    After writing all the main and auxiliary elements of the document, it wouldn’t hurt to give the document a second look. In this step, verify and ensure that everything is written down clearly and concisely, no grammatical and typographical mistakes exist (proper writing can make or break some terms and cause unnecessary confusion), and every important element which is unique to your business is present. Finally, ensure that what you’ve written down conforms to the needs of your business and the laws of the area where your business is registered. Another wise step would be to consult legal help if you wish to do so since this is a legal document.


Is an operating agreement necessary for single-member business owners?

It is not required, however, it is recommended. This is because an operating agreement can demonstrate how the owner of a single-member business intends to segregate their personal spending from those of the business. This document can also be used to designate someone to operate the firm while the owner is unable to. Furthermore, insurance companies may need an operating agreement, and it can be used to specify regulations particular to the business.

What is a limited liability company?

A Limited Liability Company (LLC) is a type of company structure that serves to combine the limited liability protection of a corporation with the tax efficiency and operational flexibility of a business collaboration. One advantage of being an owner of a limited liability company is that unlike shareholders of a corporation, they are not taxed as a distinct business entity. Instead, all earnings and losses are “distributed through” the company to each member. The members of an LLC, like partnership owners, declare gains and losses on their own federal tax returns.

Is a business plan still needed even if an operating agreement is present?

Yes, it is still necessary. Both of these essential legal documents should be present in your company. While there is some commonality, they serve different objectives. The purpose of the Operating Agreement is to establish how the firm will be operated. Other company details, such as market analysis, financial goals, product specifications, and finance requirements, are communicated in the Business Plan. If you have any more concerns or require additional clarity before drafting your LLC Operating Agreement, it is a good idea to consult with a lawyer or look into other resources for beginning a corporation.

Effectively creating a business operating agreement can be an intimidating task to undertake, but once the basics of writing this document are fully understood and once you figure out what you need to be included in the agreement, it can be an easy task. Having an effective operating agreement for your business is necessary since it gives freedom, protection, and control that the owner needs for his/her business. In this article, examples of a business operating agreement are readily available so that you can have something to use as a reference when the time comes to make one for yourself.