What Is an Operating Agreement?
An operating agreement defines how an LLC will be run. While state law will specify the most basic elements of an LLC, the members of the LLC can specify a great deal more through an operating agreement. The LLC operating agreement is the primary governing document for the business, and contains provisions such as how much each member will contribute to the LLC and the percentage of ownership of each member . For multi-member LLCs, the operating agreement will have traditional elements of a partnership in addition to being a business document. It will contain provisions that address how profits and losses are allocated, the mothering split between equity and debt, and how the LLC will be managed. For single-member LLCs the operating agreement will deal with the same issues, but it may not be as complicated. In many cases, a single-member will just have the articles of organization filed with the state and not an operating agreement.
What Are Articles of Incorporation?
For their part in the corporate structure, Articles of Incorporation are fundamental to the creation of a corporation. Essentially, they constitute the document that officially brings a corporation into existence in a legal sense with state authorities; they are the formal and legal bridge between the real world and the financial, tax and business realities that only exist once the corporation is formed.
When determining whether a business is a corporation or not, sometimes Articles of Incorporation are referred to as a Certificate or Articles of Incorporation. They can also be confused with bylaws, which are internal documents that govern a corporation from within. Though not an actual incorporation, Articles of Incorporation from the outside-in contextually provide for one essential fact: a corporation is a legal entity with specific powers under a state’s Business Corporations Act – the law that lays out the requirements for forming a corporation in that state.
Although a corporation can be formed as a matter of course under state law without any pairs of Articles of Incorporation, upon filing with the state Articles of Incorporation are essentially the closest thing to an official registration there is. Specific needs depend on individual states, but Articles of Incorporation generally need to be written in clear language to avoid any unnecessary confusion, wording errors or lack of specific details. They should also be notarized, and filed with the Secretary of State (or similar entity) of the state in which incorporation is sought in order to acquire the requisite certificate.
How Are Operating Agreements and Articles of Incorporation Different?
Primary Differences Between Operating Agreements and Articles of Incorporation
Though the operating agreement and articles of incorporation sound like similar documents, there are a few distinctions between them. Below we discuss these differences in detail.
Legal Role: For the LLC, the operating agreement supervises the business of the LLC. It is an internal document among the members to lay out the ownership percentages and distribution of the LLC. The articles of incorporation, on the other hand, establish the corporation legally and are filed with the Secretary of State. They lay out the identity of the incorporator, the corporation’s purpose, and the number and distribution of the stock.
Entities to Which They Apply: Under Florida law, articles of incorporation are only necessary for corporations. LLCs, on the other hand, file articles of organization instead. However, the operating agreement is required for all LLCs. Corporations are not required to have bylaws.
Compliance Requirements: The operating agreement is flexible and allows the members to create their own document that governs themselves. The articles of incorporation are more rigid and require you to follow certain rules.
Legal Considerations for Business Owners
From a legal perspective, having either of these documents in place is essential because they legally protect the owners of the business. If your company is an LLC, then the operating agreement will protect you to an extent by separating your business decisions as a legal entity from your own personal decisions. This means that if your LLC does something that results in a business lawsuit, for instance, then your assets are separate from the lawsuit and can’t be touched. However, this separation only works if you have an operating agreement that states these rules clearly.
Similarly, if you know that you will be seeking investment from others, you may be required by investors to have a more official legal structure as a corporation. This structure will give you legal liability protection, such that your own assets are completely separated from any potential future lawsuits and liabilities against the corporation.
On the other hand, say you decide not to spend the money or time on forming an operating agreement. Unfortunately, you are likely to lose the "limited liability" safeguard that the LLC structure gives its owners, and you may be found to be liable for any lawsuits that are brought against your company. Alternatively, if the small business isn’t formed into a corporation and you take the time to draft and file articles of incorporation, if sued, the sole owners of the company could potentially be found liable. Although it seems best practice to have corporate representation to safeguard your own assets, a large number of small business owners never file the proper documents to obtain a professional legal structure.
Using an Operating Agreement or Articles of Incorporation
After examining the key differences between an operating agreement and articles of incorporation, it’s important to understand when to use each document. Certain types of businesses are required by law to have either articles of incorporation or an operating agreement. Other business types can benefit from having one or both of these documents. For example, a business owner who wishes to operate as a corporation in Minnesota must file articles of incorporation with the Minnesota Secretary of State. In this case, there is no other option; filing articles of incorporation is the only way to form and register the corporation. If the business owner wishes to use an operating agreement with the corporation, then this document will be created and used in addition to the articles of incorporation. Even if the agreement is not filed with the state, having one can facilitate smoother internal operation of the corporation. Additionally , certain entities such as limited liability companies (LLCs) are required to have an operating agreement but not articles of incorporation. All LLCs must have an operating agreement that sets forth the organization’s internal rules and procedures, including the allocation of ownership percentages and voting rights, rules regarding financials and distributions, and necessary procedures for various company actions. However, LLCs do not need to file any paperwork with the state other than their articles of organization at the time of formation. Finally, some business owners may not have to use either document but will still benefit from having them. For instance, if you have a sole proprietorship (the simplest business structure) and absolutely plan on running the business by yourself and would never change the structure of the business, then you may not have a need for one of these documents. However, many business owners will start out as sole proprietorships and later realize the benefits of incorporating. Once this happens, the business owner will either set up an operating agreement (if they originally had a sole proprietorship) or file articles of incorporation.
Creating and Filing Operating Agreements and Articles of Incorporation
When it comes to drafting and filing articles of incorporation or an operating agreement, the process may vary depending on the type of business you run. Limited liability companies (LLCs) and corporations are subject to different requirements. Here’s what you need to know when either starting out or switching your business structure.
Articles of Incorporation
As a corporation includes officers and shareholders who own shares, they need articles of incorporation. They will include basic information about the company, such as:
These articles must then be filed with the Secretary of State. Some states require publishing info about the new corporation in a local newspaper.
Operating Agreement
The operating agreement is specific to LLCs. While it is not required by law in every state, having one will help you avoid any conflicts or misunderstandings within the company. The operating agreement will manage the business by laying out the rights and duties of all its members. It also provides a way to address issues such as:
No matter what state your company is in, you want to make sure that you have the following details covered in your operating agreement:
State regulations will also dictate what paperwork you need to file to officially form the LLC. That said, not all states require you to have an operating agreement, so be sure to check your specific state codes.
Who creates these documents and when?
In almost all situations, it’s best to seek help from a business formation attorney for these documents. As mentioned, some of the paperwork requirements vary from state to state, so it can become complicated if you are an out-of-state business owner. An attorney should know more about the requirements for your state than you do, and can make sure you do everything correctly.
The articles of incorporation will need to be filed soon after your business is formed. But there is no time limit on when you form an operating agreement. However, doing so early will reduce the likelihood of conflicts or misunderstandings further down the line.
Many people don’t bother with an operating agreement because it is not required in most states. Forming without one, however, is a mistake. This contract not only manages the business operations, but it can minimize litigation risk in the case of a dispute.
Expert Tips for Legal Compliance
Maintaining legal compliance with both an operating agreement and articles of incorporation is crucial for the proper functioning of a business and for protection against legal disputes. Both documents serve important functions, and it’s essential that they be kept current and accurate as your business evolves.
Consistency is key when it comes to maintaining an operating agreement and articles of incorporation. It’s important to ensure that the provisions of your operating agreement are consistent with those in your articles of incorporation. Any amendments to either document must be done accurately and in accordance with state laws. Any discrepancies can make it difficult to enforce your rights under either document.
If your business has undergone significant changes since the initial formation of the company, such as mergers, acquisitions, relocations or significant financial restructuring , you may need to revisit both documents to ensure that they reflect the current structure and needs of the business. This is especially important if there are major changes in the owners or management of the company.
It’s also essential to ensure compliance with any state laws that apply to your business. Each state has its own laws and regulations governing businesses, and it’s essential to be familiar with all relevant state requirements that apply to your company. Regularly reviewing both your operating agreement and articles of incorporation with legal counsel can help ensure compliance with all state laws and help you catch any potential compliance issues before they become problematic.
When in doubt, it’s always a good idea to seek legal advice on any matters related to your business structure or formation documents. An experienced business formation attorney can help you navigate any questions about your articles of incorporation or operating agreement and help ensure compliance with both.