The process of business incorporation entails certain formalities to follow and legal documents to complete. It’s a so-called filing process that will throw some paperwork to you. When you consider opening a limited liability company, there will be two main notions buzzing around. It’s the Articles of Organization and an Operating Agreement. Both are crucial LLC documents you need to have in place. What is each of them meant for? What do they cover? How do they compare? Why do you need them? In our article, you’ll find all the answers.
Understanding Articles of Organization and Operating Agreement
If you’d ask an attorney, which document is the most important one, they would say that both are a must for an LLC. Yet, before we delve into a closer comparison, let’s consider the meaning that stands behind each of them.
What Are the Articles of Organization?
The Articles of Organization or Certificate of Formation is an LLC formation document that makes an LLC legally existent and eligible and formalizes the powers and liabilities of the company as a legal entity. The document not only establishes the company but also makes it legally independent from its owners as physical persons.
Though an LLC cannot be formed without the Articles of Organization, this document can be submitted to the Secretary of State by anyone, not only the LLC members. It’s primarily meant to “bring the venture to life” at a state level and settle relations between the firm and its members.
What Is an Operating Agreement?
An Operating Agreement, on the other hand, is a document that can’t exist beyond an LLC. Broadly, the document reflects an agreement between the LLC owners on how to operate the company and other essential aspects including business ownership, management, and equity structures.
Targetting internal business regulation, this agreement is an exclusive company bylaw. As such, it needs no state registration. In the meantime, setting up clear management and operation rules, outlining profit and loss distribution and member compensations, thoroughly describing the members’ rights, duties, and obligations, to a certain extent, an Operating Agreement is even more important than the Articles of Organization. It still has the legal power and serves as a functional regulating tool that allows for smooth company management and minimizes the risk of disputes, disagreements, and conflicts between the LLC members that might adversely impact the business overall.
Main Elements of the Articles of Organization
Since LLCs are formed under state statutes, requirements toward the Articles of Organization can also slightly vary by state. However, despite its importance, the Articles of Organization are a rather generic document usually covering some basic info:
- The name of your future LLC and its registered address;
- A list of LLC members with their addresses and contact details;
- Contact data of company managers;
- Registered agent’s profile including the name and a physical address of your assigned representative and signed consent confirming that the appointed individual or entity agrees to fulfill this role for your LLC. This point is a crucial one since it’s the Articles of Organization that enact the registered agent’s status;
- The purpose of your LLC outlining the main activities your company is entitled to be engaged in. To further maintain the LLC’s legal flexibility, this section usually contains a common phrase such as “conducting any eligible and lawful activity”;
- The type of the LLC management structure specifying if you establish a member-managed LLC or a manager-managed LLC.
Typically, the Articles of Organization won’t call for more details than the above-mentioned information. The stated data are the minimum needed to give a venture a legal form. Besides, this info will become a part of your company’s public record, so providing more personal data is simply not appropriate.
Drafting this document is also an easy task. There are a whole lot of ready-made templates and sample papers available online. You won’t have to search high and low. The first place to check is the website of your state department where you can download a free form fully meeting all state requirements and complete it in a few minutes.
Main Elements of the Operating Agreement
If an Operating Agreement is not compulsory, why would you need it for your LLC? To understand that, take a look at the benefits this document offers to your company:
- Flexible management opportunities: With this internal document, you can run your business as you deem necessary under your own rules and regulations. Otherwise, your LLC’s daily activities will be governed by default laws, which are standard state rules that won’t take into account your individual business needs;
- Liability Protection Maintenance: While the Articles of Association set up your limited liability status, an agreement will help maintain it in the eyes of the state authorities. In other words, should any lawsuit arise, there will be no doubts about your liability protection status in court;
- Improved Credibility: LLCs with bylaws in place have a stronger reputation among competitors, are treated as more reliable by statutory bodies, and get more trust and loyalty from the customers.
When it comes to creating an Operating Agreement, there are no strict rules and limitations on its content as well as there are no fixed forms and templates for this document. To put it simply, the instrument can be executed in a free format. However, given its nature and purpose, there are certain key aspects and elements an Operating Agreement usually covers:
- General company info including the LLC name, members’ names, the company’s purpose, and designation, taxation methods, and the term of existence if applicable;
- Management structure embracing procedure of appointing and changing managers, as well as duties, rights, and obligations of the LLC managers and members, and their voting rights;
- Ownership structure outlining the responsibilities and powers of the LLC owners and describing procedures of introducing new members and withdrawing the existing ones. The process of transferring the rights, interests, and authorities should be also laid down in detail;
- Equity-related issues usually covering capital contributions, fundraising procedures, profit and loss distribution, and member compensations;
- Accounting and bookkeeping system;
- Business termination provisions stipulating conditions for LLC dissolution and succession of rights.
Depending on your entrepreneurial scenario and future plans, you can either write down an Operating Agreement by yourself using sample documents and information widely available online or hire a professional to create a customized version taking into account all your needs, perspectives, and minor aspects. By delegating this task to an expert, you’ll get a perfectly executed document that will work for your business like a charm. If attorney services feel rather expensive, there is an LLC service alternative that comes at a lower price and still offers professional help.
Differences Between Articles of Organization and Operating Agreements
Though both of these documents are crucial for an LLC, they are not even and have quite different purposes.
While an Operating Agreement is an optional instrument and needs no state registration, the Articles of Organization is a compulsory pre-requisite for LLC filing and is to be approved by the state. As such, this formation doc becomes a part of your company’s public record while an agreement is an internal paper applied solely within an organization and provided to third parties by request.
Unlike the Articles of Organization which is rather formal and serves the purpose of simply legalizing the business, an Operating Agreement is a full-scale operational regulation that caters to everyday business needs and makes a solid management tool.
The documents are even different in form. The company statute is a commonly short and straightforward doc covering basic and generic data. An internal agreement, on the other hand, is a lengthy paper with multiple sections, subchapters, and provisions covering specific aspects of your company’s operation and management. Notably, it’s an Operating Agreement that describes an LLC dissolution or wrap-up procedure. The Certificate of Formation is not meant for that.
To wrap it all up, it’s not a question of whether you need one doc over the other. In fact, to open an LLC and efficiently operate it afterward, you’ll need to have both documents in place. The Articles of Organization will ensure a legal form for your venture, and an Operating Agreement will help regulate owner relationships, smoothly manage your enterprise, and quickly resolve any internal disputes if they occur between the LLC members or managers.