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What is an Operating Agreement?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 08 September 2016
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An operating agreement is a type of contractual agreement that is commonly established between the partners or members of a limited liability company or LLC. The agreement typically provides two distinct advantages, with the first focusing on the definition of the company structure as being separate from the identity of the owner or owners. This type of agreement also serves many of the same functions as the bylaws of a corporation, in that it sets up the basic operational organization of the business, although the outline is normally broad enough to easily allow adaptation and expansion when deemed necessary.

In a number of jurisdictions, businesses that organize as a limited liability company find it prudent to draft and maintain an operating agreement that complies with state regulations. This is because a failure to do so could result in the business being subject to any default rules and regulations that are currently in force in that jurisdiction. Those default rules may or may not be beneficial for the business, while the structure of the operating agreement will most certainly be drafted to reflect the best interests of the company.

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One of the reasons that an operating agreement is important to the life of a limited liability company is that the very nature of this type of company organization is highly flexible. By drafting a workable operating agreement, the business establishes the relationship of partners, members, and managers to the capital accounts held by the business, the mechanisms for the distribution of profits and even the portioning or allocation of tax responsibility among the members and partners. By choosing to establish the agreement, the members and partners are able to control this type of portioning or allocation of rights and responsibilities that would be somewhat difficult to manage under any state default rules that would apply if no operating agreement were in place.

While the operating agreement must remain in compliance with governmental regulations at all times, this type of document can be amended with relative ease. In many cases, the amendments require the support of a majority of the members of the LLC, with majority either being defined as a controlling bloc of interest among several members or a numerical majority of the members regardless of how much interest each member holds. Since the process can move forward with relatively little internal red tape to slow the process, amending an operating agreement and quickly implementing the changes often allows the limited liability company to adapt to changing market conditions with greater ease than some other types of companies.

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